January 15, 2014
RICHARDSON PATEL LLP
405 LEXINGTON AVENUE, 49TH FLOOR
NEW YORK, NEW YORK 10174
www.richardsonpatel.com
(212) 869-7000
January 15, 2014
Elizabeth M. Murphy
Secretary
U.S. Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
Re: Release No. 33-9497, File No. S7-11-13 – Regulation A and Exemptions Under Section 3(b) of the Securities Act of 1933
Dear Ms. Murphy:
I am writing to you in response to the request by the Securities and Exchange Commission (SEC) for comment on the recently proposed rulemaking (Proposed Rules) to amend Regulation A to implement Section 401 of the Jumpstart Our Business Startups Act (JOBS Act or the Act). Also dubbed Regulation A+, the intent of this section of the JOBS Act was to meaningfully enhance capital formation opportunities for smaller companies while retaining significant investor protections. The Act left much discretion to the SEC in fashioning rules to implement its provisions under Section 401.
In general, we are pleased with the Proposed Rules. Overall, they strike a very reasonable balance between greatly improving the attractiveness of Regulation A exempt public offerings while adding additional disclosure and reporting requirements and investment limits to protect investors. If implemented properly, the Regulation A+ regime should encourage many more companies to consider the benefit of a US initial public offering without many of the delays, costs and substantial risks of a full IPO registration on Form S-1, and without feeling pressure to seek a public listing outside the United States.
More specifically, we believe that retaining the ability to test the waters with potential investors and expanding its availability after filing the offering statement helps reduce cost and risk in public offerings. Mirroring the JOBS Act provisions for emerging growth companies to keep initial offering statements confidential allows companies to obtain SEC review without alerting competitors. The ability for existing holders to resell up to $15 million of securities elevates the attractiveness of Regulation A+ while increasing the public float, thereby increasing trading volume and helping strengthen the trading market for a newly public company.
Of course adding electronic filing, access equals delivery and reduced disclosure obligations in offering statements also meaningfully improves the incentive for issuers to turn to Regulation A+ offerings.
Most significantly, we strongly support the preemption of state blue sky review of these offerings and do not believe it should be required even if a multistate review process is developed. The SEC correctly pointed out that investors are well protected in the Proposed Rules. In order to create a regime that will be attractive to issuers as an alternative to a traditional IPO under a Form S-1, Congress mandated the preemption for qualified purchasers, which the SEC has correctly defined as any purchaser in a Regulation A+ offering. One main reason Regulation A was almost never used was the delay, cost and uncertainty of divergent state review of the offerings, in some cases conflicting with the disclosure standards of the SEC and in some other cases based on arbitrary merit standards. The preemption will create a major incentive for companies seeking a public trading stock to utilize Regulation A+ and the states can continue to play a key role in enforcement and regulation of market intermediaries.
The new reporting requirements in Tier II offerings allow investors to have regular and current information on important developments while easing some of the burdens of full reporting. In addition, audited financial statements meaningfully improve investor protection and confidence, as do the proposed bad actor disqualifications. And the limits on investment amount based on income or net worth we believe are appropriate and necessary to ensure that individual investors are not unduly exposed due to participating in a Regulation A+ offering.
Based in part on the requests for comment, however, we have several suggestions which we believe could further improve this already very attractive set of Proposed Rules.
Create a Swift Path to Full Reporting Status
While the Proposed Rules create a scaled disclosure regime, many companies will still seek the greater prestige and fundraising capability from full Securities Exchange Act reporting status. The OTC Bulletin Board and national securities exchanges all require it, as do many investment banks raising money for smaller companies.
Under the Proposed Rules, following a Regulation A+ public offering, a company will still be regarded as non-reporting under the Securities Exchange Act. To then become reporting, a company would need to prepare and file a full Form 10 (subject to SEC review), even though much of the information will already have been in the public domain after SEC review. This is an expensive, duplicative and sometimes a conflicting and a time-consuming process.
The Regulation A+ offering statement will have essentially the same material information as a full Form S-1 with some relatively minor exceptions (especially with the proposed elimination of the QA format), and will have completed full SEC review and approval. Therefore, we propose the ability to file short Form 8-A to obtain Exchange Act reporting status at any time within 12 months following a Regulation A+ offering, so long as the issuer has complied with all Tier II reporting requirements during that time. Then immediately thereafter it will be subject to all the obligations of a full reporting company, including insider reporting, and be subject to proxy and tender offer rules. One would think the SEC would see benefit in encouraging issuers to become subject to these additional reporting obligations.
Allow Tier II Reports to Qualify as Current Public Information For Rule 144
Non-reporting companies depend on shares becoming tradable under Rule 144 as much as reporting companies. While the holding periods are longer, the opportunity to create liquidity from a private offering into a non-reporting company makes that investment much more attractive, improving the opportunities for capital formation and growth. Of course Rule 144 requires the company to have current public information, and in response to the SECs request for comment, we strongly urge them to allow Tier II reporting to satisfy the current public information requirement for purposes of Rule 144.
Issues Regarding Investment Limit: None for Accredited Investors
The Proposed Rules limit on investment to 10% of the greater of income or net worth is ingenious as it allows anyone to invest as long as they limit their exposure, in a fashion not dissimilar to the current proposals and JOBS Act provisions regarding crowdfunding. This protects investors but maximizes an issuers opportunity to conduct a true public offering. However, we respectfully believe the Proposed Rules could be enhanced.
It will be difficult to apply the proposed 10% limit to non-natural persons as investors. Most small businesses that may invest do not necessarily have an easy ability to determine their income or net worth unless they regularly prepare financial statements. Many such businesses file tax returns, but are pass-through tax entities making even a determination of real income sometimes difficult.
In addition, accredited investors already are exempt from any investment limits in private offerings where there is no disclosure obligation from the issuer. Here there will be substantial disclosure which is reviewed and approved by the SEC staff.
Therefore, we propose the following. First, accredited investors should not have any investment limit, and if a proposed investor certifies itself as accredited then no limit should be required on their investment. Second, we believe any non-individual investor with at least $100,000 in assets or $100,000 in revenue in the previous fiscal year also should not face investment limits. Or the limit, if any, on non-individual investors that are not otherwise accredited should be based on assets or revenue rather than income or net worth, as these are difficult to determine in small businesses, IRAs and the like who may comprise many of these investors.
Blank Checks, Shell Companies and SPACs Should Be Permitted to Use Regulation A+
The Proposed Rules maintain the status quo in prohibiting blank checks but permitting shell companies which are not blank checks from utilizing Regulation A+. For an issuer to be a shell but not a blank check, it would need to have no or nominal assets and no or nominal operations but also have a business plan that is not a plan simply to acquire other businesses. Yet SEC interpretations have made clear that a legitimate startup company, even with virtually no assets or operations, was not meant to be pulled into the definition of shell. Therefore, if these companies are not shells, one wonders what set of facts could lead to an issuer that is a shell but not a blank check. Any legitimate business plan or statement of specificity as to the utilization of a majority of the offering proceeds, it seems, is enough to avoid the shell designation. But, then, is it also not a blank check? That is not clear.
We believe these distinctions are archaic and, to some extent, the accident of history. The SEC decided to define the term shell company when it created Securities Act Rule 144(i) in 2007, without acknowledging the prior use of the term blank check. That moniker dates back to the 1992 adoption of Securities Act Rule 419, which severely restricted public offerings by blank check companies.
If the Proposed Rules provide that some shells be permitted to conduct a Regulation A+ offering, we propose that all shells, and all blank checks, also be permitted. Much has changed since Rule 419 was adopted over 20 years ago. Plus Regulation A+ would have in some ways more investor protections with the investor limits and dollar offering amounts than even current Rule 419 would provide.
The special purpose acquisition company (SPAC) market also showed that, despite some cyclical market challenges, shells raising millions of dollars can go public, trade on all exchanges and complete reverse mergers legitimately working with major investment banking firms.
Separately, we believe Rule 419 could be modernized in a manner to make its use not only more attractive but much more investor protective than current shell merger practices. This is because Rule 419s proscriptions can be sidestepped with shells created by filing Form 10 or by taking over an already public and trading company whose operations have ceased. We believe Rule 419 should be amended to retain IPO escrow and certain other protections, but eliminate the shareholder approval requirement.
However, absent such change, Regulation A+ offers an opportunity to create a similar regime. We propose that shell companies and blank checks be permitted to utilize Regulation A+ with the same restrictions as any other issuer if at least $10 million is being raised, but if raising less than $10 million in Tier II, require that (a) monies raised be placed into escrow, minus underwriters compensation and 10% for IPO expenses, until a reverse merger is completed, (b) a combination with an operating business be completed within three years, (c) full Form 10 information is disclosed regarding a pending reverse merger to investors who have 15-20 days to reconfirm their investment or receive their money back, (d) there be no requirement that a certain percentage of investors reconfirm, and (e) as suggested above, accredited investors have no limit on the investment they make in the IPO.
We believe this proposal would help create new public vehicles with cash to provide a speedier and less costly process for a company to go public and raise capital, all while providing appropriate protections for investors.
Foreign Companies Should Be Able to Use Regulation A+
It is not entirely clear why the SEC many decades ago decided to limit Regulation A+ to US and Canadian issuers. In our modern, electronically connected very small world, any company seeking a US stock listing and meeting the requirements for doing so should be able to. And utilizing International Financial Reporting Standards will further encourage foreign companies to do so. These companies already can go public with reduced disclosure as a foreign private issuer, with no dollar limit on offerings or investment limit for investors. There does not appear to be any reason why all companies on Earth should not be able to utilize Regulation A+.
The Offering Limit Should be Increased
Some companies seeking a public listing may wish to raise more than $50 million in one year. An exciting pre-revenue biotechnology company, or defense innovator, or social media company may simply prefer the quicker process that Regulation A+ can offer and may not be ready for the national exchanges. Thus, the opportunity to be limited to federal review of disclosure, scaled reporting and the like, can help some of these companies as they raise money and grow until they are ready for a large exchange.
We propose that, when required by the JOBS Act, the SEC seek to increase the offering limit under Regulation A+ to $100 million per year. Alternatively, the $50 million limit could apply per offering but not with a time limit. Further, the SEC should consider seeking to eliminate the offering limit for certain issuers, such as those that are pre-revenue.
In conclusion, we are very pleased with the Proposed Rules, and hope the suggested enhancements herein will be seriously considered along with other comments received. Please do not hesitate to contact the undersigned with any questions or comments.
Sincerely yours,
RICHARDSON PATEL LLP
By:_/s/David N. Feldman_____
David N. Feldman, Partner