Proposed Rules
Although Section 401(b) of the JOBS Act does not exempt offerings made under Section 3(b)(2) and the related rules from state law registration and qualification requirements, it added Section 18(b)(4)(D) to the Securities Act.767 That provision states that Section 3(b)(2) securities are covered securities for purposes of Section 18 if they are “offered or sold on a national securities exchange” or “offered or sold to a qualified purchaser, as defined by the Commission pursuant to [Section 18(b)(3)] with respect to that purchase or sale.” Section 18(b)(3) provides that “the Commission may define the term ‘qualified purchaser’ differently with respect to different categories of securities, consistent with the public interest and the protection of investors.”
766 As discussed in Section II.C.3.a. above, Part I of Form 1-A focuses, in part, on issuer eligibility, and requires issuers to make an eligibility determination at the outset of filling out Form 1-A.
767 Section 18 of the Securities Act generally provides for exemption from state law registration and qualification requirements for certain categories of securities, defined as “covered securities.” See Section 18(c), 15 U.S.C. 77r(c). State securities regulators retain authority to impose certain filing and fee requirements and general antifraud enforcement authority with respect to covered securities. See Section 18(c), 15 U.S.C. 77r(c).
Commenters in the pre-proposal stage suggested that the cost of state securities law compliance, which they identified as an obstacle to the use of Regulation A, would discourage market participants from using the new exemption. In addition, the GAO, as required by Section 402 of the JOBS Act, conducted a study on the impact of state securities laws registration and qualification requirements on offerings conducted under Regulation A and found that state securities laws were among several central factors that
may have contributed to the lack of use of Regulation A.768
In light of the issues raised by commenters and in the GAO Report, as well the substantial investor protections included in the proposed rules to amend Regulation A and implement Title IV of the JOBS Act, we proposed to define the term “qualified purchaser” in a Regulation A offering to consist of: (1) all offerees in a Regulation A offering and (2) all purchasers in a Tier 2 offering.769 We indicated in the Proposing Release that we believed this approach would protect offerees and purchasers in Regulation A securities, while streamlining compliance and reducing transaction costs.
We proposed to preempt state securities laws registration and qualification requirements with respect to all offerees in a Regulation A offering, in order to allow issuers relying on Regulation A to communicate with potential investors about their offerings using the internet, social media, and other means of widespread communication, without concern that such communications might trigger registration requirements under
state law.770 We further proposed to preempt state securities laws registration and
768 See fn. 90 above.
769 Proposed Rule 256.
770 We understand that some state securities regulators do not require the registration of broadly advertised offerings such as internet offerings, if the advertisement indicates, directly or indirectly,
qualification requirements with respect to all purchasers in a Tier 2 offering to help make Regulation A a more workable means of capital formation. We also noted our belief that the substantial investor protections embedded in the proposed rules, including issuer eligibility conditions, limitations on investment, disclosure requirements, qualification process, and ongoing reporting requirements of Tier 2, in combination, could address potential concerns that may arise as a result of preemption.
Under the proposed rules, state securities regulators would retain their authority
to:
require the filing of any document filed with the Commission and the payment of filing fees;
investigate and bring enforcement actions against fraudulent securities transactions and unlawful conduct by broker-dealers in such offerings; and
enforce the filing and fee requirements by suspending the offer or sale of securities within a given state for the failure to file or pay the appropriate fee.771
As noted in the Proposing Release, it was our preliminary view that the additional requirements for Tier 2 offerings would meaningfully bolster the protections otherwise embedded in Regulation A and therefore a different treatment than Tier 1 offerings is appropriate.
that the offering is not available to residents of that state. See, e.g., Washington State Dep’t of Financial Institutions, Securities Act Policy Statement – 16, available at: http://dfi.wa.gov/sd/securitiespolicy.htm#ps-16; see also NASAA Reports ¶ 7,040 (regarding NASAA resolution, dated January 7, 1996, which encourages states to take appropriate steps to exempt from securities registration offers of securities over the Internet).
771 Section 18(c) (Preservation of Authority) of the Securities Act, 15 U.S.C. 77r(c).
Comments on Proposed Rules
The preemption of state securities law registration and qualification requirements contemplated in the proposed “qualified purchaser” definition received an extensive amount of public commentary. Commenters were sharply divided on the need for state securities law preemption in Regulation A.
Many commenters objected to the preemption of state securities law registration and qualification requirements.772 The views of these commenters were based on the following arguments:
A “qualified purchaser” means a purchaser with specialized skill, experience or knowledge.773
772 Letter from A. Heath Abshure, Arkansas Securities Commissioner, February 20, 2014 (“ASD Letter”); CFA Letter; CFA Institute Letter; Letter from Rep. Stephen F. Lynch, et al, U.S. House of Representatives, June 3, 2014 (“Congressional Letter 2”); Letter from Sen. Barbara Boxer, et al,
U.S. Senate, Aug. 1, 2014 (“Congressional Letter 4”); Cornell Clinic Letter; Groundfloor Letter (suggesting that the Commission should at least evaluate NASAA’s coordinated review program for 12 months); Karr Tuttle Letter (acknowledging that state preemption may still be necessary for states not participating in NASAA’s new coordinated review program); Letter from William F. Galvin, Secretary, Commonwealth of Massachusetts, December 18, 2013 (“Massachusetts Letter 1”); Massachusetts Letter 2; MCS Letter; Letter from Andrea Seidt, President, et al., North American Securities Administrators Association (NASAA), February 19, 2014 (“NASAA Letter 1”); NASAA Letter 2; Letter from William Beatty, President, North American Securities Administrators Association (NASAA), February 11, 2015 (“NASAA Letter 3”); Letter from Jack
E. Herstein, Assistant Director, Nebraska Department of Banking and Finance, February 10, 2014 (“NDBF Letter”); Letter from Chad Johnson, Bureau Chief, Investor Protection Bureau, New York State Attorney General’s Office, New York, May 7, 2014 (“NYIPB Letter”); Letter from Irving L. Faught, Administrator, Oklahoma Department of Securities, March 24, 2014 (“ODS Letter”); Letter from Damaris Mendoza-Román, Assistant Commissioner, Office of the Commissioner of Financial Institutions, Puerto Rico, March 5, 2014 (“PRCFI Letter”); Letter from Hon. Jesse White, Illinois Secretary of State, et al., March 4, 2014 (“Secretaries of State Letter”); Letter from Lindsay M. Scherber, May 8, 2014 (“Scherber Letter”); Letter from Janet M. Tavakoli, President, Tavakoli Structured Finance, Inc., February 24, 2014 (“Tavakoli Letter”); Letter from John Morgan, Securities Commissioner, Texas State Securities Board, March 21, 2014 (“TSSB Letter”); WDFI Letter.
773 See, e.g., ASD Letter; CFA Letter; Congressional Letter 4; Cornell Clinic Letter; Massachusetts Letter 1; NASAA Letter 2; ODS Letter; PRCFI Letter; WDFI Letter.
The qualifications of the purchaser are key, not the nature of the issuer or the offering. Thus, the proposed definition of “qualified purchaser” is contrary to the plain meaning of this term.774
The legislative history of the National Securities Markets Improvement Act of 1996 (NSMIA)775 suggests that definitions of “qualified purchaser” must include an investor sophistication test.776 The Commission made similar statements on the “qualified purchaser” definition in a 2001 Proposing Release.777
Congress considered preemption in the context of a provision to preempt offerings conducted through a broker-dealer in an early draft of Title IV of the JOBS Act, but then purposefully excluded such broad preemption from the final statute.778
The Commission’s cost-benefit analysis of preemption was inadequate because it largely ignored investor protections, the benefits of state regulation, perceived resource constraints at the Commission, and preemption’s impact on investor confidence in the markets.779
774 See, e.g., CFA Letter; Massachusetts Letter 1; NASAA Letter 2; PRCFI Letter; Tavakoli Letter; WDFI Letter.
775 Pub. L. 104-290, 110 Stat. 3416 (Oct. 11, 1996).
776 See, e.g., ASD Letter; Karr Tuttle Letter; Congressional Letter 4; Massachusetts Letter 1; Massachusetts Letter 2; NASAA Letter 1; NASAA Letter 2; NDBF Letter; NYIPB Letter; ODS Letter; PRCFI Letter; Secretaries of State Letter; Tavakoli Letter; WDFI Letter.
777 Rel. No. 33-8041 (Dec. 27, 2001) (the “2001 Proposing Release”).
778 See, e.g., ASD Letter; CFA Letter; Congressional Letter 2; Congressional Letter 4; Groundfloor Letter; Massachusetts Letter 1; Massachusetts Letter 2; NASAA Letter 2; NDBF Letter; NYIPB Letter; Secretaries of State Letter; Tavakoli Letter; WDFI Letter.
779 See, e.g., CFA Letter; Groundfloor Letter; Massachusetts Letter 2; NASAA Letter 2; Scherber Letter; WDFI Letter.
Although the GAO Report conducted under Section 402 of the JOBS Act cited compliance with state securities law review and qualification requirements as a factor in the lack of use of Regulation A, it also noted lengthy Commission reviews of Form 1-A filings.780
States play a unique role in regulating securities offerings due to their localized knowledge and resources, which aid in detecting fraud and facilitating issuer compliance.781
The investor protections included in the proposal do not act as an adequate substitute for state review and comment on offering statements.782
The states have adopted and implemented a new coordinated review program, designed to address many of the perceived inefficiencies associated with state registration.783
Many other commenters expressed their support for preemption, as proposed.784
These commenters made the following arguments:
780 See, e.g., CFA Letter; Massachusetts Letter 2; NASAA Letter 2; WDFI Letter.
781 See, e.g., NASAA Letter 1; ODS Letter; PRCFI Letter; WDFI Letter.
782 See, e.g., CFA Letter; CFA Institute Letter; MCS Letter; NASAA Letter 2; Scherber Letter; TSSB Letter; WDFI Letter.
783 See, e.g., ASD Letter; CFA Institute Letter; Cornell Clinic Letter; Groundfloor Letter; Karr Tuttle Letter; Massachusetts Letter 1; Massachusetts Letter 2; NASAA Letter 1; NASAA Letter 2; NASAA Letter 3; NYIPB Letter; PRCFI Letter; Secretaries of State Letter; Tavakoli Letter; TSSB Letter; WDFI Letter.
784 ABA BLS Letter; Letter from Kendall Almerico, Crowdfunding Expert, Attorney and CEO, Fund Hub and ClickStartMe, February 11, 2014 (“Almerico Letter”); Andreessen/Cowen Letter; B. Riley Letter; BIO Letter; Campbell Letter; Canaccord Letter; CFIRA Letter 1; CFIRA Letter 2; Letter from Rep. David Schweikert, et al, U.S. House of Representatives, Sept. 25, 2014 (“Congressional Letter 3”); DuMoulin Letter (noting that Canadian issuers conducting simultaneous offerings in Canada would otherwise be subject to three levels of review); Letter from Stanley Keller, Edwards Wildman Palmer LLP, April 3, 2014 (“Edwards Wildman Letter”) (recommending defining “qualified purchasers” as “accredited investors” if the proposed preemption is not adopted); Letter from Daniel Eng, CEO, March 20, 2014 (“Eng Letter”);
The proposed rules provide substantial investor protections to investors.785
State securities law review of offering statements is a significant impediment to the use of Regulation A.786
The Commission has the authority to preempt state qualification and review requirements.787
States continue to have the authority to, among other things, bring anti-fraud enforcement actions and to review the publicly filed disclosure documents before sales occur.788
Fallbrook Technologies Letter; Gilman Law Letter; McCarter & English Letter; Guzik Letter 1 (see also Guzik Letter 2 (suggesting that if the proposed preemption is not adopted to consider adopting an accredited investor style definition for “qualified purchaser,” but with a lower income or net worth test)); Letter from Todd Hart, Aug. 20, 2014 (“Hart Letter”); Heritage Letter; Letter from Charles Huynh, February 24, 2014 (“Huynh Letter”); IPA Letter; Kisel Letter; Letter from Akbert P. Kretz, Ph.D., Founder/Manager, Mentor, March 11, 2014 (“Kretz Letter”); KVCF Letter; Ladd Letters; Leading Biosciences Letter; Letter from Bruce E. Methven, Securities Law Attorney, March 23, 2014 (“Methven Letter”); Milken Institute Letter; MoFo Letter; Letter from Donald R. Hancock, CEO, Moloney Securities Co., Inc., February 20, 2014 (“Moloney Letter”); Letter from Jason Akel, President, New Food Ventures LLC, March 12, 2014 (“New Food Letter”); OTC Markets Letter; Letter from Jesse J. Palomino, February 25, 2014 (“Palomino Letter”); Paul Hastings Letter; Public Startup Co. Letters; REISA Letter; Richardson Patel Letter; SBIA Letter; Letter from Bradley L. Staples, MBA, University of Utah, February 21, 2014 (“Staples Letter”); Letter from Chris Sugai, February 21, 2014 (“Sugai Letter”); SVB Financial Letter; SVGS Letter; Letter from Ryan Hawxhurst, Founder and CEO of Unorthodocs Printing LLC, February 21, 2014 (“Unorthodocs Letter”); U.S. Chamber of Commerce Letter; Letter from Gregory S. Fryer, Esq., Partner, Verrill Dana LLP, July 15, 2014 (“Verrill Dana Letter 2”); Letter from John Warren, Esq., February 24, 2014 (“Warren Letter”); WR Hambrecht + Co Letter.
785 See, e.g., ABA BLS Letter; Almerico Letter; B. Riley Letter; Campbell Letter; Canaccord Letter; CFIRA Letter 1; Congressional Letter 3; Edwards Wildman Letter; Fallbrook Technologies Letter; Gilman Law Letter; Guzik Letter 1; Guzik Letter 2; KVCF Letter; Leading Biosciences Letter; Milken Institute Letter; MoFo Letter; OTC Markets Letter; Paul Hastings Letter; Richardson Patel Letter; Verrill Dana Letter 2; WR Hambrecht + Co Letter.
786 See, e.g., ABA BLS Letter; Almerico Letter; BIO Letter; Campbell Letter; Canaccord Letter; Congressional Letter 3; DuMoulin Letter; Edwards Wildman Letter; Fallbrook Technologies Letter; Gilman Law Letter; Guzik Letter 1; Guzik Letter 2; Kisel Letter; Kretz Letter; KVCF Letter; Ladd Letters; Leading Biosciences Letter; McCarter & English Letter; Milken Institute Letter; Moloney Letter; OTC Markets Letter; Paul Hastings Letter; REISA Letter; Richardson Patel Letter; SBIA Letter; Staples Letter; SVB Financial Letter; U.S. Chamber of Commerce Letter; Verrill Dana Letter 2.
787 See, e.g., ABA BLS Letter; BIO Letter; Campbell Letter; Edwards Wildman Letter; Guzik Letter 1; Heritage Letter; IPA Letter; KVCF Letter; Public Startup Co. Letters; Richardson Patel Letter;
U.S. Chamber of Commerce Letter; Verrill Dana Letter 2.
NASAA’s coordinated review program as implemented will remain inefficient due to internal conflict, the application of merit review standards and the program’s inability to bind participants in the event of disagreements among the states.789
Many commenters that expressed general support for preemption, as proposed, also recommended applying it on an expanded basis.790 Some commenters recommended preempting state regulation of secondary trading in Regulation A securities,791 and some recommended preempting state regulation of Tier 1 offerings.792
Alternatively, several commenters recommended possibly eliminating the Commission’s review of Regulation A offerings to varying extents.793 Two commenters recommended eliminating the Commission’s review of Tier 1 offerings.794 One of these
788 See, e.g., Congressional Letter 3; Heritage Letter; KVCF Letter; Methven Letter; REISA Letter.
789 See, e.g., ABA BLS Letter; BIO Letter; Canaccord Letter; Congressional Letter 3; Edwards Wildman Letter; Guzik Letter 2; KVCF Letter; Ladd Letters; Milken Institute Letter; Paul Hastings Letter; REISA Letter; Richardson Patel Letter; SVB Financial Letter; Verrill Dana Letter 2.
790 ABA BLS Letter; Campbell Letter; Congressional Letter 3; Guzik Letter 1; Hart Letter; Heritage Letter; IPA Letter; KVCF Letter; Ladd Letter 2; Milken Institute Letter; OTC Markets Letter; Paul Hastings Letter; Public Startup Co. Letter 1; SVB Financial Letter.
791 ABA BLS Letter; IPA Letter (recommending preempting for resales of all securities of a Tier 2 issuer that is current in Regulation A reporting); KVCF Letter; OTC Markets Letter (recommending preemption for at least Regulation A securities that are not penny stocks); Paul Hastings Letter; SVB Financial Letter.
792 Andreessen/Cowen Letter; Campbell Letter; Congressional Letter 3; Guzik Letter 1 (recommending preemption with audited financial statements and a substantially lighter disclosure regime compared to Tier 2); Heritage Letter; Ladd Letter 2 (recommending preemption if company adopts internal controls and meets continuing disclosure requirements, including yearly audited financials); Milken Institute Letter (recommending preemption if audited financial statements are included in the “initial filing”); Public Startup Co. Letter 1; SVB Financial Letter (recommending preemption with additional, unspecified disclosure obligations). See Section II.I. below for additional recommended changes to Tier 1.
793 Groundfloor Letter; Ladd Letter 2; Public Startup Co. Letter 5; Verrill Dana Letter 2.
794 Ladd Letter 2; Public Startup Co. Letter 5.
commenters recommended only doing this for offerings that are “local” in nature.795 One commenter recommended having a single state review, in lieu of a review and qualification by the Commission, if the Commission’s staff is unwilling to review Regulation A offerings “promptly with content-appropriate standards.”796 One commenter recommended completely eliminating the Commission’s review if NASAA’s coordinated review program promotes a “robust” Regulation A market.797