As one commenter noted, “[t]he challenges posed by the necessity of responding to both federal and state reviews and coordinating overlapping but potentially
1022 See ABA BLS Letter; Andreessen/Cowen Letter; Almerico Letter; B. Riley Letter; BIO Letter; Campbell Letter; Canaccord Letter; CFIRA Letter 1; CFIRA Letter 2; Congressional Letter 3; DuMoulin Letter; Eng Letter; Fallbrook Technologies Letter; Gilman Law Letter; Guzik Letter 1; Hart Letter; Heritage Letter; Huynh Letter; IPA Letter; Edwards Wildman Letter; Kisel Letter; Kretz Letter; KVCF Letter; Ladd Letter 2; Leading Biosciences Letter; McCarter & English Letter; Methven Letter; Milken Institute Letter; MoFo Letter; Moloney Letter; New Food Letter; OTC Markets Letter; Paul Hastings Letter; Palomino Letter; Public Startup Co. (several letters); REISA Letter; Richardson Patel Letter; SBIA Letter; Staples Letter; Sugai Letter; SVB Letter; SVGS Letter; Unorthodocs Letter; U.S. Chamber of Commerce Letter; Verrill Dana Letter 2; Warren Letter; WR Hambrecht + Co Letter.
1023 See Groundfloor Letter. This commenter does not separately estimate the component of the cost due to state registration.
1024 See Letter from Paul Hastings, LLP, November 26, 2013.
Another commenter referenced one issuer’s offering in the State of Washington in the amount of
$750,000, with legal and accounting expenses estimated at $10,000 and the offering statement prepared without outside securities counsel and reviewed by the state within less than three months. See WDFI Letter. We do not believe that this cost estimate would be representative of costs for issuers registering in multiple states rather than a single state or for issuers involving outside securities counsel.
inconsistent comments and approvals have helped to make the existing Regulation A scheme unworkable for most smaller companies.”1025 Preemption of state securities review and qualification requirements for Tier 2 offerings will eliminate the burdens of responding to multiple reviews and thus provide for a more streamlined review process than exists under existing Regulation A. We expect that this, in turn, will make Tier 2 a more attractive capital raising option for issuers than existing Regulation A. Accordingly, we believe that by eliminating the requirement for state qualification, the final rules’ preemption for Tier 2 offerings will result in greater use of amended Regulation A and thereby facilitate capital formation.
We recognize that commenters were divided on the issue of preemption, and those who objected to preemption of state securities review and qualification requirements cited benefits of state review.1026 These include additional investor protection benefits arising from the localized knowledge and resources of state regulators that may aid in detecting fraud and facilitating issuer compliance.1027 Some of these
1025 See ABA BLS Letter.
1026 See ASD Letter; Cornell Clinic Letter; CFA Letter; CFA Institute Letter; Groundfloor Letter (arguing 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); MCS Letter; Congressional Letter 2; Congressional Letter 4; NASAA Letter 1; NASAA Letter 2; NASAA Letter 3; NDBF Letter; NYIPB Letter; ODS Letter; PRCFI Letter; Scherber Letter; Secretaries of State Letter; Massachusetts Letter 1; Massachusetts Letter 2; Tavakoli Letter; TSSB Letter; WDFI Letter. One commenter stated its view that the Commission’s proposal to preempt state regulatory review contained little consideration of the adverse costs that come with preemption, particularly the potential harm to investors, including harm investors might incur in the absence of state review in the area of small and thinly traded company offerings. See NASAA Letter 2.
1027 According to the 2014 NASAA enforcement report for 2013, securities violations related to unregistered securities sold by unlicensed individuals, including fraudulent offerings marketed through the Internet, remain an important enforcement concern. The report does not detail the number and category of violations by type of exemption from registration. See NASAA Enforcement Report, available at: http://www.nasaa.org/wp-content/uploads/2011/08/2014- Enforcement-Report-on-2013-Data_110414.pdf.
commenters also noted that the launch of NASAA’s coordinated review program could streamline state review of offerings among participating states.
We acknowledge that the preemption of state qualification for Tier 2 offerings may have an impact on investor protection by eliminating one level of government review. In addition, merit-based review of offerings undertaken by some states may, in some cases, provide a level of investor protections different from the disclosure-based review undertaken by the Commission. State regulators may also have a better knowledge of local issuers, which could help in detecting fraud, especially in offerings by small, localized issuers. If investors require higher returns because of a perceived increase in the risk of fraud as a result of preemption, issuers may face a higher cost of capital. We are unable to predict how the amendments to Regulation A will affect the incidence of fraud that may arise in Regulation A offerings.
Several factors could mitigate these potential impacts. First, under Section 18(c), the states retain the ability to require the filing with them of any documents filed with the Commission and to investigate and bring enforcement actions with respect to fraudulent transactions. Second, we believe that amended Regulation A provides substantial protections to purchasers in Tier 2 offerings. Under the final rules, a Regulation A offering statement will continue to provide substantive narrative and financial disclosures about the issuer. Further, the final rules require offering statements to be qualified by the Commission before an issuer can conduct sales. Additional investor protections would be afforded by Regulation A’s limitations on eligible issuers and bad actor disqualification provisions. The final rules for Tier 2 offerings provide further protection by requiring audited financial statements in the offering circular, ongoing reporting, and
an investment limitation for purchasers who do not qualify as accredited investors.
The anticipated costs and benefits of state preemption will depend on key offering characteristics and issuer disclosure requirements. In particular, smaller offerings with a narrow investor base, such as those expected to be conducted under Tier 1, are more likely to be concentrated in fewer states and to benefit from geographic-specific information of state regulators as part of the review process.1028 In contrast, larger offerings that seek a broader investor base, such as those expected to be conducted under Tier 2, are more likely to span multiple states. For Tier 2 offerings, the additional disclosure, audited financial statements, and transactional requirements relative to Tier 1 offerings are expected to provide an additional layer of investor protection, thus reducing the need for, and the expected benefits of, state review. State preemption for Tier 2 offerings should lower the compliance burdens imposed on issuers, and partly offset the costs of the increased disclosure and transactional requirements.
In general, we expect that issuers in Tier 1 offerings will face significantly lower offering costs as a result of not being subjected to the requirements of audited financial statements and ongoing reporting in the final rules. For these offerings, the local knowledge of state regulators is anticipated to add value to the review process to the
1028 We believe that issuers conducting Tier 1 offerings are more 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 or region or a small number of geographically dispersed states. For example, based on our analysis, 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. We recognize, however, that the characteristics of Tier 1 issuers in Tier 1 offerings relying on amended Regulation A in the future may differ from the characteristics of issuers that rely on existing Regulation A (for example, due to the higher maximum offering size for Tier 1 offerings in the final rules, compared with the maximum offering size in existing Regulation A).
extent that the issuer and the investor base are more likely to be localized. Thus, state qualification is more likely to have incremental investor protection benefits in Tier 1 offerings relative to Tier 2 offerings. Moreover, to the extent that Tier 1 offerings are more likely to be concentrated in fewer states, the cost of complying with state review procedures is likely to be diminished for these types of offerings.
Some commenters also pointed to the increased burden on Commission resources as a cost of state preemption.1029 Compared with the baseline of the existing Regulation A, we anticipate a possible increase in the burden on Commission resources as a result of the increase in the Regulation A maximum offering size and other provisions intended to make Regulation A more attractive to prospective issuers. However, we believe this increase would also occur under the alternative of no state preemption for Tier 2 offerings. While state review of Tier 2 offerings could potentially confer incremental investor protection benefits to the extent a thorough Commission staff review is
constrained by the increased burden on agency resources, overall we do not believe this effect will be substantial.
As an alternative to preemption for Tier 2 offerings, we considered the option of state qualification by one state or a subset of states or the option of state review under NASAA’s coordinated review program.1030 According to one commenter, the coordinated review program creates value by defining concrete service standards regarding the timeliness of various steps of the qualification process and by introducing
1029 See WDFI Letter and NASAA Letter 2.
1030 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/.
more legal certainty.1031 According to another commenter, the coordinated review program will eliminate costs of identifying and addressing individual state requirements and will provide an expedient registration process.1032 We recognize that the coordinated review process ultimately may reduce processing time and streamline certain state requirements for issuers registering in multiple states when compared to independent review conducted by individual states. To date, however, we are aware of only a few issuers that have utilized the coordinated review process, so currently there is limited evidence available to us to evaluate the effectiveness and timeliness of coordinated review, especially in the event that more potential Regulation A issuers seek state qualification under this process. While it is possible that the coordinated review process may reduce costs for issuers as compared to individual state review and qualification, it would add cost and complexity for issuers seeking an exemption under amended