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Regulation A Exemption

25. What is a “Regulation A” exemption?

Regulation A is a “conditional small issues” exemption from registration available for issuances that meet certain characteristics. Like Section 3(11), Regulation A provides for an exemption of the actual securities issued under the exemption. As such, the securities are not restricted from later sale.

•    Note: The exemption is available for the issuer but is not available for broker-dealers offering the security for sale.

General Limitations – The following general limitations apply to all Regulation A exemptions:

•    Private, Non-Reporting Company – The issuer cannot have stock registered with the SEC under Section 12 (i.e., cannot have stock that is traded on a public exchange) or be a reporting company under Section 15(d) of Securities Exchange Act of 1934 (’34 Act).

•    US Company – The company must be a US or Canadian-based company.

•    Operating Company – It cannot be an investment company, shell company, or involve fractional interests in oil or gas rights.

Types of Regulation A Exemption – Regulation A is actually divided into two classes of issuances, as follows:

•    Tier 1 Issuance: The maximum amount of the issuance is $5 million in a 12-month period. There is no limit on the number of amount of securities purchased by any investors.

•    Tier 2 Issuance: The maximum amount of the issuance is $50 million in a 12-month period. An investor may only purchase a number of securities valued at 10% of her annual income or 10% of her net worth, whichever is less.

Regulation A Disclosures

Regulation A is a middle ground between complying with the full registration and disclosure requirements of Section 5. The issuance requires review by the SEC prior to sale of the securities. The issuer must file an offering statement containing both non-financial and financial disclosures about the company and the issuance. This document has several components, including offering circular and financial statements. The issuer’s CEO, CFO, and majority board members, and any selling shareholder must sign the offering statement certifying the information contained therein. This certification subjects these individuals to liability for any material omissions or misstatements. While this exemption does entail a filing requirement, the filing is far less demanding than those completing the entire registration process.

•    Note: The issuer cannot solicit investors, make any binding commitments for sale, or sell any securities before the request for issuance and exemption is reviewed and approved by the SEC. There is, however, an exception that allows the issuer to “test the waters”.

Regulation A and General Solicitation

Regulation A allows the issuer of securities to “test the waters” for interested investors. That is, the issuer can use a written document or a radio or television broadcast to seek feedback from interested investors. The purpose of this provision is to allow the issuer to determine, prior to preparing the detailed offering disclosure documents, whether or not there is sufficient interest from investors to proceed with the issuance. The key limitations are that the test-the-waters communication must be filed with the SEC on the date of use.

•    Note: Failing to file the “test-the waters” communication does not automatically forfeit the exemption, but it can prejudice future issuances under this provision.

Regulation A and State Regulations

Regulation A securities are not exempt from state regulation. This means that, even though the federal exemption applies, states may require that the issued securities be registered in the state and, in some states, undergo a merit review. Perhaps most importantly, many states do not allow general solicitation of investors unless the securities being sold are registered. This would strictly limit the open solicitation of purchasers in person or through television, radio, or Internet. So, even though Regulation A allows for testing the waters, the state may require state registration prior to doing so.

•    Note: A prohibition against general solicitation requires that an issuer approach regular business contacts or professional brokers to generate interest in the issuance.

•    Discussion: Why do you think Regulation A offers an exemption that accompanies a registration requirement? Given the extent of the disclosure requirements, do you think Regulation A is more or less attractive to issuers than full registration? Why?

•    Practice Question: ABC Corp decides to issue securities in an effort to raise $45 million in financing. What are some of the restrictions that ABC Corp must understand when considering Regulation A?

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