With the approval by the House of Representatives of the Senate version of S. 2155, a number of financial regulatory reform measures were sent to the President’s desk for signature and became law on May 24. While some of these measures, especially those related to banking, are more controversial, there are a few provisions related to US securities law that have received broad support. These changes include allowing issuers to better use smaller national stock exchanges, increasing the Investment Company Act exemption threshold for venture capital funds, increasing the annual limit for exempt issuances for employee stock plans, and allowing Exchange Act reporting companies to utilize Regulation A.
As a market leader in Regulation A, we are very interested in the possibilities of the change to Regulation A that will allow reporting companies to use Regulation A. As a quick refresher, the 2015 amendments to Regulation A created two tiers. Tier 1 allows issuers to raise up to $20 million every 12 months and requires qualification by each state into which offers will be made along with qualification by the SEC. Tier 2 allows issuers to raise up to $50 million every 12 months, includes financial statement audit requirements, and only requires qualification by the SEC (states are preempted from requiring the offering statement to be qualified by state regulators).
When the SEC amended Regulation A, it decided to limit its use by Exchange Act reporting companies because it took the view that Regulation A should be limited to smaller and early stage companies that have not yet registered a class of securities. Congress, on the other hand, recognized the utility of reporting companies being able to undertake offerings under Regulation A, which leads us to where we are now.
How will this change the market? We see two primary results of this change. First, smaller reporting companies that are not exchange listed will be able to utilize the lower cost of Regulation A to raise capital in public offerings. Second, some smaller private investment in public equity (“PIPE”) offerings may move to Regulation A.
For smaller reporting companies that are not listed on a national securities exchange, raising follow-on capital may be prohibitively expensive. Not only do they have the compliance costs of submitting a registration statement with the SEC, they also are required to qualify the offering in each state in which offers will be made because state review is not preempted. These requirements often push companies to take on burdensome private capital or loans with unfavorable terms, ultimately harming existing investors. Further, the small reporting companies are strictly limited in the manner in which they could “test the waters” prior to effectiveness of their registration statements with the SEC and qualification by each state. By allowing companies in this situation to use Regulation A, smaller reporting companies could undertake a testing the waters campaign and take advantage of the lower costs associated with Regulation A.
It is also possible that Regulation A may become an alternative to PIPE offerings. PIPEs are often used for their relatively quick timetable for receiving capital from private investors. However, PIPE issuers are typically required by those investors to file a registration statement to allow for the resale of the securities purchased in the PIPE offering. Those investors also typically demand the PIPE offering be at a discount relative to the public price of the securities. Regulation A would allow for skipping that second step of filing a post-sale registration statement because the securities would be freely tradable immediately, and the issuer may be able to set a price more closely aligned to the public price of its securities. While the annual $50 million limit may restrict some use by companies that are considering PIPE offerings, the overall compliance cost of a follow-on Regulation A offering could be lower than that of a PIPE offering.
We believe there is a lot of potential for these changes to Regulation A to make follow-on capital raising for currently reporting companies more efficient and transparent. This could have positive impacts not only on those reporting companies that are now able to undertake Regulation A offerings, but could also help the entirety of the Regulation A market mature into an even more effective tool for micro- and small-cap companies to raise public capital.