SEC Prevails in Regulation A+ Litigation
Regulation A+, which became effective on March 25, 2015, permits the offering of up to $50,000,000 in securities in any twelve-month period, subject to the certain requirements (a “Tier 2 Offering”). Tier 2 Offerings are not subject to state securities laws registration and qualification requirements due to federal preemption provided by Section 18 of the National Securities Market Improvement Act of 1996 (NSMIA) because such securities are offered or sold to a “qualified purchaser” (as defined by the Commission).
When the proposed rules for Regulation A+ were issued by the SEC, several states filed comment letters raising concerns about federal preemption. Once final rules for Regulation A+ were adopted, the Montana State Auditor Monica Lindeen filed a motion on behalf of the Montana Commissioner of Securities and Insurance (“MCSI”) to stay its enactment of Regulation A+, which the SEC denied. As a result, on April 14, 2016, the Assistant Attorney General of Massachusetts, along with MCSI, petitioned the D.C. Court of Appeals for review of the final rules of Regulation A+. On June 14, 2016, the Court denied the petition and ruled the SEC’s rules are permitted under the Securities Act.
Why were Montana and Massachusetts (as well as several other states’ security regulators) so upset with the federal preemption around Tier 2 Offerings by the SEC? Primarily, they expressed concern that their citizens would not be adequately protected by the requirements of a Tier 2 Offering. They argued that the SEC exceeded its authority by adopting a definition of “qualified investor” for Tier 2 Offerings that permits potential investors that are neither accredited nor “sophisticated” to invest up to 10% of the greater of their annual income or net worth. These states claimed that Tier 2 Offerings are more likely to be fraudulent than other types of offerings, pointing to the relatively higher rate of fraud in Rule 506 offerings (which are also subject to federal preemption), compared to Regulation A offerings. For this reason, these states argued that preemption of state laws providing for oversight over such offerings unnecessarily expose their citizens to misinformation, fraud, and financial harm. They contended this risk is compounded by the fact that the SEC had not added any resources to adequately protect potential investors from potentially misleading or fraudulent issuer offerings.
The SEC has made clear it disagrees with such assertions. The SEC has stated that the increased requirements of a Tier 2 Offering (as compared to a Tier 1 offering) are sufficient protection for investors, negating the need for such investors to be accredited or sophisticated. These increased requirements include mandating audited financial statements in the offering statements and providing for ongoing reporting. In addition, the SEC has pointed out that the states still maintain oversight over Tier 1 offerings, which are anticipated to be more local in nature. However, since Tier 2 offerings are anticipated to be larger national offerings the SEC reasoned that the offering process needs to be more streamlined, and that additional oversight by states would be unnecessarily duplicative and redundant, adding that adequate investor protection is provided by the more stringent disclosure requirements and limitations on how much unsophisticated investors may invest. Lastly, the SEC has pointed out that preemption under Tier 2 Offerings does not remove states’ ability to prosecute fraud after the issuance.
The D.C. Circuit court ruling upholding the rules regulating Tier 2 Offerings confirmed that the SEC had the authority to make these decisions and preempt state securities laws registration and qualification requirements by its adoption of the definition of a “qualified purchaser” in a Tier 2 Offering. The court concluded that the SEC acted properly when it defined a “qualified purchaser” under a Tier 2 Offering to include purchasers who, while not accredited investors, limited their purchases to no more than 10 percent of their annual income or net worth. The court ruled that when Congress enacted the JOBS Act, it gave the SEC the proper authority to define the term “qualified purchaser” for different types of securities offerings. Although the D.C. court acknowledged the new rules “stripped a layer of state review” away, it stated that investors would still be adequately protected by the new rules for Tier 2 Offerings.
As time passes, it will be interesting to see whether the contentions of the SEC or states regarding the level of adequate protection necessary for investors in a Tier 2 Offering will be borne out.