Streamline Regulation “A” To Encourage Its Use In Small Offerings

Wednesday, October 25, 2006

Prof. Rutheford Campbell, University of Kentucky College of Law, http://

Abstracted from: Regulation A: Small Businesses' Search For "A Moderate Capital"

Delaware Journal of Corporate Law - Vol. 31, No. 1, Pgs. 77-123

No cost-efficient exemptions.
An important source of new jobs and innovation, small businesses are invaluable to the economy. While some garner bank financing, many need a modest amount of capital from other sources in order to grow. However, the costs involved in a public offering, especially the expense of professional underwriters, are so high that they cannot be justified if a small amount is being raised. Exemptions from 1933 Act registration are available, but law professor Rutheford Campbell explains that they do not provide the small business with a cost-efficient means of raising capital. For example, the federal exemption for intrastate offerings could be useful to some small companies, but those issuers would also need to comply with state blue-sky laws, significantly limiting the number of offers the issuer could make. Small issuers can use only the exemption under 1933 Act Section 4(2) for transactions "not involving a public offering." This exemption cannot be used to offer shares widely or to sell stock to unsophisticated purchasers. The three rules under Regulation D­Rules 504, 505, and 506 ­forbid general advertising and limit the number of unaccredited investors. Regulation A, promulgated under 1933 Act Section 3(b), seems like the perfect solution, but unfortunately, it is almost never used. (In 1988, the last year in which the SEC collected and reported the data, just 70 Reg. A offerings were filed with the SEC; Reg. A filings from 1995 through 2004 averaged just eight a year.)

Regulation rarely used.
Regulation A allows public offerings under $5 million by issuers that do not report under the 1934 Act, provided they are not "blank-check" companies (i.e., a company with "no specific business or plan except to locate and acquire" some to-be-discovered opportunity, according to the SEC) and have not violated any so-called bad boy provisions. The regulation allows companies to solicit widely for investors and does not impose any requirements on offerees' suitability. Issuers must file an offering statement with the SEC on Form 1-A, which includes a circular for investors about the company's business, risk factors, officers and directors, and other information. The offering circular must also include specified unaudited financial information prepared in accordance with GAAP. According to the author, small issuers rarely use Regulation A because the offering statement is so costly to produce, and some fear the time and expense involved in SEC review of the document. Yet Regulation A does include a valuable test-the-waters provision, which allows issuers to solicit potential investors and determine the level of interest in the offering before going to the expense of preparing an offering circular.

Blue-sky compliance even harder.
Compliance with state blue-sky laws may prove even more difficult for small issuers, the author fears. The National Securities Markets Improvement Act of 1996 preempted state securities regulation in some areas, but it did not preempt from state regulation offerings made under Regulation A. The exemptions under blue-sky laws are not particularly helpful to small issuers. The small-offering exemption limits the number of offerees, undercutting the ability to offer securities broadly, a major benefit of Regulation A. Small businesses may choose to register with each state by qualification or, for offerings of up to $1 million, on the simpler SCOR (Small Corporate Offering Registration) form. However, these methods of complying with the blue-sky laws are too costly for small issuers wishing to raise small amounts of capital. Some states allow registration by coordination with a Regulation A offering, letting issuers file the same Form 1-A with each state. Because many states do not allow registration by coordination, however, issuers that wish to offer shares publicly in those states will not be able to rely on this option.

Some suggested changes.
Regulation A could be a useful exemption from registration for small businesses to raise small amounts of capital if certain requirements were changed. The author recommends that offerings of less than $2 million be permitted under Regulation A while larger offerings be registered. The requirements to comply with Regulation A should be streamlined so that small businesses can comply easily and cheaply. The mandatory financial disclosures should be reduced. Small companies should be required to disclose only material risk factors. The issuer should be entitled to use Regulation A unless it fails to comply with the rule in a material respect. The regulation should retain its test-the-waters provision, and offerees should be given the offering circular at least three days before the actual sale. To simplify the process for small businesses, the SEC should no longer review and comment on offering statements, although the issuer should continue to deliver copies of the offering circular to the Commission. The National Securities Markets Improvement Act should be expanded so that Regulation A offerings are exempted from state securities laws.

Abstracted from Delaware Journal of Corporate Law
published by Widener University School of Law
4601 Concord Pike, PO Box 7286, Wilmington, DE 19803.

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