Final Rules
For the reasons discussed below, we are adopting the “qualified purchaser” definition in Regulation A, substantially as proposed. In the final rules, a “qualified purchaser” for purposes of Section 18(b)(4)(D)(ii) of the Securities Act includes any person to whom securities are offered or sold in a Tier 2 offering. Because of the requirements for all Tier 2 offerings, all purchasers in Tier 2 offerings persons must be either accredited investors or persons who limit their investment amount to no more than 10% of the greater of annual income or net worth (for natural persons), or 10% of the greater of annual revenue or net assets at fiscal year end (for non-natural persons).
To address commenter concerns and avoid potential confusion as to the application of the preemption provisions in Tier 1 offerings, the final definition of “qualified purchaser” does not include offerees in Tier 1 offerings. While the final rules permit Regulation A issuers to test the waters and make offers in the pre-qualification period at the federal level, in light of the concerns raised by state regulators about the
795 Public Startup Co. Letter 5.
796 Verrill Dana Letter 2.
797 Groundfloor Letter.
proposed rule’s expanded use of solicitation materials798 and what we anticipate to be the generally more local nature of Tier 1 offerings,799 we believe it is appropriate, in this context, for the states to retain oversight over how these offerings are conducted.
Although we acknowledge that this could potentially inhibit the use of solicitation materials in certain Tier 1 offerings, for these smaller, more localized offerings, we think the states should be permitted to regulate the use of solicitation materials.
Given the sharply divided views of commenters on the “qualified purchaser” definition included in the Proposing Release, we want to clarify the scope of the Commission’s authority under the Securities Act to define such a term and the effect the final qualified purchaser definition will have on the continued ability of the states to regulate offers and sales within their jurisdiction. We continue to believe that the substantial investor protections embedded in the final rules for Tier 2 offerings, including the requisite qualifications of the issuer, offering, and eventual purchasers, as well as the particular characteristics associated with this category of securities, support the limited preemption of state securities laws registration and qualification requirements adopted in the final rules.
NSMIA and the JOBS Act
As noted above, some commenters questioned the ability of the Commission to adopt a “qualified purchaser” definition that includes any person to whom securities are
798 Massachusetts Letter 2; NASAA Letter 2; WDFI Letter. These commenters suggested that the Commission require the filing of solicitation materials before the time of first use, as, in their view, the antifraud and other civil liability provisions of the federal securities laws are not an adequate substitute for the investor protections afforded by an advance filing requirement for solicitation materials, while also noting that problems with the use of solicitation materials are compounded by the provisions for access equals delivery of final offering circulars.
799 See Section II.H.3.d. below; see also fn. 830 below.
offered or sold in a Tier 2 offering.800 These commenters suggested that a qualified purchaser definition under Section 18(b)(3) of the Securities Act must be based on attributes of the purchaser, not the nature of the issuer or offering. These commenters stated that broad preemption was contemplated in the legislative history of Title IV of the JOBS Act and expressly rejected by Congress.
Title I of the NSMIA, referred to as the “Capital Markets Efficiency Act of 1996” (the “Efficiency Act”),801 was, as its name suggests, enacted to promote efficiency and capital formation in the financial markets.802 The Efficiency Act realigned the respective responsibilities of federal and state securities regulators in the context of the dual system of securities offering registration that existed before enactment of the statute.803 The
Efficiency Act achieved this regulatory realignment by amending Section 18 of the Securities Act to provide for exemption from state law registration and qualification requirements for certain categories of securities, defined as “covered securities.”
Section 18(b)(3) provides that “[a] security is a covered security with respect to the offer or sale of the security to qualified purchasers, as defined by the Commission by rule.” Congress stated in Section 18(b)(3) 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.” The JOBS Act804
800 See fn. 772 above.
801 NSMIA, section 101 (Short Title).
802 H.R. Rep. No. 622, 104th Cong. 2d Sess. at 1 (1996) (House Report).
803 As enacted, NSMIA included five separate titles, each of which served a different purpose in the overarching statutory goal of improving national securities markets. See preamble and Section 1 to NSMIA.
804 The stated purpose of the JOBS Act is to “increase American job creation and economic growth by improving access to the public capital markets . . . .” See JOBS Act (Preamble).
amended Section 18 by adding to its list of “covered securities” transactions involving securities that are exempt from registration pursuant to a rule or regulation adopted pursuant to Section 3(b)(2) and that are “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.”805
By its terms, Section 18(b)(3) provides the Commission with the express authority
to adopt rules that define a “qualified purchaser.” The provision does not prescribe specific criteria that the Commission must consider in determining, or the manner in which it must determine, a purchaser to be “qualified.” Furthermore, Section 18(b)(3) states that the definition of qualified purchaser may be different for different categories of securities. This means that, rather than considering the characteristics of the purchaser in isolation, the Commission may adopt a qualified purchaser definition that is also tailored to reflect the characteristics of the particular type of issuer or transaction. Further, Section 18(b)(3) does not proscribe any particular terms or characteristics that the Commission must include in any rules defining qualified purchaser with respect to a given category of securities. What it does instead is require that any rules so adopted be consistent with the public interest and the protection of investors.
Unlike Section 18(b)(3), which provides for preemption with respect to offers or sales to qualified purchasers in any context, Section 18(b)(4)(D)(ii) provides for preemption specifically with respect to transactions exempt from registration pursuant to
805 JOBS Act section 401(b) (adding Section 18(b)(4)(D)(ii) to the Securities Act). Section 401(b) also included in the list of “covered securities” transactions involving Section 3(b)(2) securities that are offered or sold on a national securities exchange, see Section 18(b)(4)(D)(i). See also Title III of the JOBS Act, which added to the list of “covered securities” in Section 18(b)(4)(C) transactions involving securities issued pursuant to Section 4(a)(6).
Section 3(b)(2). As such, the preemption afforded under Section 18(b)(4)(D)(ii) necessarily encompasses the mandatory requirements for conducting an exempt offering pursuant to Section 3(b)(2). These include, among other things, that the civil liability provisions of Section 12(a)(2) must apply and that an issuer must file audited financial statements with the Commission annually.806 Other potential requirements left to the discretion of the Commission include provisions for ongoing reporting, bad actor disqualification, and requirements for electronic filing of offering materials.807
We believe that the terms of Section 18(b)(3) and Section 18(b)(4)(D)(ii)—read in conjunction—provide the Commission with discretionary authority to adopt a “qualified purchaser” definition that reflects the particular characteristics of transactions exempt from registration pursuant to Section 3(b)(2). Thus, in determining who should be considered a qualified purchaser for purposes of the amendments to Regulation A, we have considered not only the mandatory features of Section 3(b)(2), but also many of the discretionary features contained in our final rules, such as the requirement that purchasers in Tier 2 offerings be limited to accredited investors or persons otherwise subject to specified investment limitations.
We recognize that a number of commenters disagreed with this approach.808
Some stated that a “qualified purchaser” definition adopted by the Commission must at a minimum be based on attributes of the purchaser, such as a person’s wealth, income, or sophistication,809 and noted that the Commission had highlighted such factors in a 2001
806 15 U.S.C. 77c(b)(2)(D), (F).
807 See 15 U.S.C. 77c(b)(2)(G); 15 U.S.C. 77c(b)(4).
808 See fn. 772 above.
809 See, e.g., NASAA Letter 2.
Proposing Release to define a “qualified purchaser” pursuant to Section 18(b)(3).810 The 2001 Proposing Release, however, contemplated that state securities review and qualification requirements would be preempted in all categories of transactions to the extent that sales were made to “accredited investors.” By contrast, our rules to implement Title IV of the JOBS Act provide for preemption in the more limited circumstances in which the requirements of Section 3(b)(2) and the rules adopted thereunder are satisfied.
In the 2001 Proposing Release, we noted that certain aspects of NSMIA’s legislative history suggest that a qualified purchaser definition should include investors that are sophisticated and capable of protecting themselves. In addition, we asked questions about the proposed approach to the definition and whether other potential factors mentioned in the legislative history, such as the national character of an offering, could or should bear on potential qualified purchaser definitions adopted pursuant to
Section 18(b)(3).811
We do not believe that the 2001 Proposing Release is inconsistent with the qualified purchaser definition for Regulation A that we are adopting today. The 2001 Proposing Release was not a Commission statement on the scope of all permissible definitions for a qualified purchaser adopted pursuant to Section 18(b)(3). Rather, it expressed a preliminary interpretive view of certain aspects of the legislative history of NSMIA in the context of a proposed rulemaking that would have equated “qualified
810 2001 Proposing Release. In this release, the Commission proposed to define a “qualified purchaser” to be an “accredited investor,” as that term is defined under Rule 501(a) of Regulation D.
811 See 2001 Proposing Release, Section II.B. (for example, asking questions about the national character of offerings and the potential for eliminating redundancies and inefficiencies in the application of disparate state standards); see also House Report, at 31.
purchaser” with the definition of an “accredited investor” for sales by any category of issuer in any type of transaction.812 While it may have been appropriate to focus on attributes of the purchaser when crafting a “qualified purchaser” definition that would have applied in a broad set of possible transactions, as in the 2001 Proposing Release, the definition being adopted today serves a different purpose because it applies only in Regulation A offerings. Indeed, Section 18(b)(3) contemplates that the term “qualified purchaser” can be defined “differently with respect to different categories of securities.”
The enactment of the JOBS Act in 2012, and in particular its addition of Section 18(b)(4)(D)(ii) to the Securities Act has caused us to consider the definition of qualified purchaser specifically within the context of transactions under the new Section 3(b)(2) exemption. This is a new and different context in which to consider the
definition of qualified purchaser than existed at the time of the 2001 Proposing Release. In this new context, we believe that the definition of qualified purchaser that we are adopting is appropriately tailored to these transactions because, as explained above, the requirements applicable to Tier 2 offerings include numerous provisions designed to protect investors, including, among other things, a requirement that all purchasers in these offerings be either accredited investors or persons who are subject to investment limitations.
We do not agree with the commenters who assert that broad state securities law preemption was expressly rejected by Congress in Title IV of the JOBS Act. The legislative record indicates that the only form of state securities law preemption directly
812 See 2001 Proposing Release, Section I.C., II.B. The Commission did not adopt final rules based on the 2001 Proposing Release.
contemplated, but not adopted, in the drafting of Title IV of the JOBS Act was for offers and sales through a broker or dealer.813
Section 18 of the Securities Act and the Effect of Preemption on State Securities Laws
As discussed above, some commenters expressed concern about the effect preemption would have on the ability of state securities regulators to remain actively involved in Regulation A offerings.814 We believe it is important to clarify the effect preemption will have on the ability of state securities regulators to continue to play a vital role in the supervision of Regulation A securities.
Under Section 18(a) of the Securities Act, no law, rule or regulation of any state requiring the registration or qualification of securities applies to a covered security or to a security that will be a covered security upon completion of the transaction.815 Further, with respect to a covered security, no state law, rule or regulation shall prohibit, limit, or impose, among other things, any conditions upon the use of any offering document816
813 See, e.g., Congressional Record Volume 157, Number 166 (Wednesday, Nov. 2, 2011), p. 7231 (Statement of Rep. Peters: “Finally, the gentleman [Rep. Schweikert (AZ)] has also worked with Democrats on the remaining issue of contention, and that was the preemption of State law. [Rep. Schweikert’s] substitute amendment to H.R. 1070 removes the exemption from State level review that was previously provided to an issuer using a broker-dealer to distribute and [sic] issue.”) Cf. H.R. Rep. No. 112-206, at 2 (2011).
814 See, e.g., NASAA Letter 2, at 10.
815 15 U.S.C. 77r(a)(1).
816 Under Section 18(d), the term ‘‘offering document’’ has the same meaning given the term ‘‘prospectus’’ in first portion of section 2(a)(10) and includes a communication that is not deemed to offer a security pursuant to a rule of the Commission. For these purposes, the term “prospectus” means any prospectus, notice, circular, advertisement, letter, or communication, written or by radio or television, which offers any security for sale or confirms the sale of any security.
that is prepared by or on behalf of the issuer, or, based on the merits of such offering or issuer, upon the offer or sale of any covered security.817
While covered security status under Section 18 prohibits the states from requiring the registration or qualification of such securities, Section 18(c) preserves the power of the states in several important areas.818 Under Section 18(c), the states retain:
the jurisdiction to investigate and bring enforcement actions with respect to fraudulent securities transactions and unlawful conduct by broker-dealers;819
the ability to require issuers to file with the states any document filed with the Commission, solely for notice purposes and the assessment of fees, together with a consent to service of process and any required fee;820 and
the power to 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.821
As the name of the statute that added Section 18 to the Securities Act suggests, the preemption of state securities laws is about improving the “efficiency” of our capital markets by eliminating unnecessary, duplicative regulation of securities offerings at both
817 15 U.S.C. 77r(a)(2)-(3).
818 15 U.S.C. 77r(c).
819 15 U.S.C. 77r(c)(1).
820 15 U.S.C. 77r(c)(2). For example, even though state securities law registration requirements are preempted in offerings pursuant to Rule 506 of Regulation D, 17 CFR 230.506, many states continue to require the filing of Form D notices and amendments, and most of them charge a filing fee. See, e.g., https://www.efdnasaa.org; cf. 15 U.S.C. 77r(b)(4)(E).
821 15 U.S.C. 77r(c)(3).
the federal and state level.822 It is not about eliminating investor protections or otherwise limiting the continued involvement of the states in such offerings.823
State Coordinated Review Program for Section 3(b)(2) Securities
Since the proposed rules to implement Title IV of the JOBS Act were issued in December 2013, NASAA has implemented a multi-state coordinated review program for Regulation A offerings, the goal of which is to reduce the state law disclosure and compliance obligations of Regulation A issuers.824 Under the coordinated review program, issuers are required to file Regulation A offering materials with the states via electronic mail. The administrator of the coordinated review program must then select a lead disclosure examiner and, where applicable, a lead merit examiner, which are responsible for drafting and circulating comment letters to the participating jurisdictions, and for seeking resolution of those comments with the issuer and its counsel. As enacted,
the program contemplates a twenty-one business day turnaround from the time of filing of an offering statement until the issuer receives comments from the states.825 The coordinated review program’s review protocol also modifies (or disapplies altogether) certain of NASAA statements of policy for offerings undergoing coordinated review.
822 House Report, at 1.
823 Id., at 16 (Noting the reason behind the legislation that eventually became NSMIA was a clear need for modernization and that “there continues to be a substantial degree of duplication between Federal and State securities regulation, and that this duplication tends to raise the cost of capital to American issuers of securities without providing commensurate protection to investors or our markets.”).
824 A description of NASAA’s coordinated review program can be found at: http://www.nasaa.org/industry-resources/corporation-finance/coordinated-review/regulation-a- offerings/. The Proposing Release also discusses this program, as it was contemplated and proposed at that time. See Proposing Release, at Section II.H.
825 An illustrated timeline for NASAA’s multi-state coordinated review program is available at: http://www.nasaa.org/wp-content/uploads/2015/03/Coordinated-Review-Chart.pdf.
Where, however, an issuer elects to offer or sell Regulation A securities in at least one merit state, the coordinated review program may require the issuer to apply NASAA’s statements of policy to the offering as a whole (i.e., not solely for purposes of offers or sales within such merit review state(s)).
At the proposing stage, we indicated that a number of open questions remained about the then-proposed multi-state review program. In the intervening time, many questions have been answered, largely relating to the final adoption and implementation of the program by a vast majority of the states.826 Other crucial questions, however, remain, such as whether the program will be able to address the concerns related to state securities law compliance identified by the GAO Report and commenters,827 and whether the program can continue, as contemplated, in the face of numerous filings by issuers that seek to participate in the streamlined process. As of the date of this release, we are aware of three issuers that have elected to seek qualification at the state level pursuant to the protocols of the multi-state coordinated review program.828 While the program, as contemplated in its enactment, could potentially reduce the state law disclosure and compliance obligations of issuers,829 the limited experience of issuers with the program prevents us from being able to fully evaluate it at this time. We note that Tier 1 issuers
826 At this time, it is our understanding that 49 of NASAA’s 53 constituent members have agreed to participate in the coordinated review program.
827 See, e.g., GAO-12-839, at 14 (discussing the varying standards and degrees of stringency applied during the qualification and review process in merit review states); see also, e.g., ABA BLS Letter, at 14.
828 See, e.g., Groundfloor Letter (the first issuer to rely on NASAA’s coordinate review program, with the exception of having to seek qualification outside of the coordinated review program in the state of Georgia).
829 Id. (suggesting that in its experience the benefits of NASAA’s coordinated review program outweighed the approximately $50,000 cost of the average Regulation A offering); see also NASAA Letter 3.
may well benefit from the coordinated review program as it continues to develop. We remain concerned, however, that, even under the coordinated review program, state securities law registration and qualification requirements would be unnecessarily duplicative for, and impose unnecessary costs on, securities issued in Tier 2 offerings. In light of the recent efforts of state securities regulators to address concerns about the costs associated with state qualification of Regulation A offering statements, however, the ongoing implementation and development of the coordinated review program,
particularly as it may operate within Tier 1 offerings, may provide additional data that will aid any future evaluation of whether such a program could effectively operate within the context of larger, more national Tier 2 offerings as an alternative to preemption.
Application of State Securities Law in Tier 1 and Tier 2 Offerings
As we noted in the Proposing Release, in light of the issues raised by commenters and in the GAO report, we remain concerned that costs associated with state securities law compliance, even under a coordinated review program, may deter issuers from using amended Regulation A, which could significantly limit the impact of the exemption as a tool for capital formation. In considering our approach to preemption in the final rules, particularly as we evaluate what is consistent with the public interest and the protection of investors, we have taken into account the amended Regulation A regime, including the distinctions between the two tiers and in particular the additional protections provided in Tier 2 beyond the requirements of Tier 1.
In addition to certain basic requirements that are applicable to both tiers, Tier 2 issuers will be subject to significant additional requirements, some arising directly from
Section 3(b)(2) and others that we have imposed through our discretionary authority under that section. For example, the financial statements that Tier 2 issuers include in their offering circulars are required to be audited, and Tier 2 issuers must file audited financial statements with the Commission annually. Tier 2 issuers also must provide ongoing reports on an annual and semiannual basis with additional requirements for interim current event updates, assuring a continuous flow of information to investors and the market. In addition, purchasers in Tier 2 offerings must be either accredited investors or subject to limitations in the amount they may invest in a single offering. Finally, as with Tier 1 offerings, Tier 2 offering statements will be filed electronically, reviewed and qualified by Commission staff, and the offerings are subject to both limitations on eligible issuers and “bad actor” disqualification provisions. In consideration of these requirements, as well as our view, as discussed in greater detail below, that Tier 2 offerings are more likely to be national rather than local in nature, we believe that preemption of state securities law registration and qualification requirements is appropriate for purchasers in these offerings.
We believe that the final rules for Regulation A create two different categories of securities for purposes of Section 18(b)(3). The requirements for Tier 1 issuers create a category of securities that is more local in character, while Tier 2 offerings involve a category of securities that is more national in character. In this regard, to the extent an issuer seeks to raise money through a public offering pursuant to Regulation A, the distinctions between the requirements for Tier 1 and Tier 2 will provide issuers with a meaningful choice at the outset between initial and ongoing offering costs and requirements.
Tier 1 issuers are not required to include audited financial statements in their offering statements, nor are they required—as contemplated by Section 3(b)(2)—to file audited financial statements with the Commission annually. They are further not subject to any ongoing reporting, beyond the requirements contained in Part I of Form 1-Z. While the final rules raise the offering limitation in Tier 1 to $20 million in a 12-month period, which we believe should increase the general utility of the tier, such offerings by virtue of the lower dollar amounts that can be raised in comparison to Tier 2 offerings, as well as the form filing requirements and the lack of ongoing reporting, will likely be conducted by a different set of issuers than those that conduct offerings pursuant to
Tier 2. Specifically, we think that issuers conducting Tier 1 offerings are likely to be smaller companies whose businesses revolve around products, services, and a customer base that will more likely be located within a single state, region, or a small number of geographically dispersed states.830 We believe that these issuers will typically not seek or, on the basis of their business models, be able to: (i) raise capital on a national scale; or (ii) create a secondary trading market in their Regulation A securities.
By contrast, we believe that the higher offering limitation for Tier 2 offerings, the higher costs associated with complying with the audited financial statement and ongoing reporting requirements, as well as the requirement to sell to “accredited investors” or otherwise limit the amount of securities sold to non-accredited investors, will necessitate that such offerings be offered and sold on a larger and more national scale. Additionally,
830 For example, issuers of securities in the seven offering statements qualified by the Commission pursuant to Regulation A in 2014 indicated, on average, that they were seeking qualification in approximately five states per offering. The financial statements provided by these issuers further indicated, on average, that issuers had approximately $1.2 million in assets. No issuer indicated assets greater than $3.6 million, while two issuers indicated assets of less than $20,000.
an issuer electing to conduct a Tier 2 offering would likely do so, or be required by its investors to do so, in order to provide ongoing reports in a manner that will facilitate, or otherwise result in, secondary trading on a national level. While issuers conducting Regulation A offerings for less than $20 million are free to choose between the requirements of either tier, we believe that the initial and ongoing costs and limitations associated with complying with Tier 2 will provide for the natural separation of offerings into the respective tiers with issuers in more local offerings electing to comply with the less onerous requirements of Tier 1.
As noted above, some of the basic requirements of the offering statement are applicable to both tiers, and issuers of securities pursuant to either tier will remain subject to the same review and comment process by the staff of the Division of Corporation Finance before qualification. On this basis, some commenters argued that the same reasons supporting the preemption of state securities law registration requirements for Tier 2 offerings suggests that the Commission should also extend preemption to Tier 1
offerings.831