Written by: Phil Feigin
The remaining changes to the securities world in the JOBS Act have the potential to be much more impactful on daily investor lives. It’s one thing to talk in the abstract about financial reporting companies with $1 billion in annual revenue (are there even any in Colorado? Coors maybe) and Wall Street analysts touting stocks, but that’s not as palpable as getting a cold call at dinner from a private placement salesman, or an emailed pitch from someone you’ve never heard of. That’s more my beat.
REPEAL NUMBER THREE: Regulation A
Regulation A had become a trick question on a law school securities test. A “mini-registration” process with the SEC, the $5 million cap did not expand with the times. Add full state registration (and merit) review and preemption of Rule 506 offerings, and Reg. A had reduced to a regulatory relic. The JOBS Act breathes new life into the provision and process, by raising the offering limit from $5 million to $50 million, and preempting the states from reviewing the offering statements (they are not called prospectuses). The SEC, and perhaps FINRA and underwriters, will be the only things standing between the issuers and prospective investors. Shares purchased will be freely tradable (not that any kind of market is assured). My old penny stock joints are aching at the prospects.
Perhaps helping to level things out, a perhaps less noticed provision of the Act breathes new life into another near vestigial provision of the Securities Act of 1933, section 12(a)(2). The relevance of this section was reduced significantly by the Supreme Court in Gustafson v. Alloyd, 513 U.S. 561 (1995). Under the provision, buyers can sue sellers for making untrue statements or omitting material facts in making the sales. In Gustafson, the Court held that the relief was limited to public offerings (registered or unregistered and illegal) because those are the only offerings that involve a “prospectus.” This had the effect of depriving investors in private placement offerings of a fraud remedy under the ’33 Act. Their only recourse was an action under Rule 10b-5, with its culpable mental state, reliance and causation requirements, or state law.
Under the JOBS Act changes, “sellers” of securities under the new Reg. A can now be sued by buyers under section 12(a)(2). This is more a negligence standard than the steeper hills to climb in a Rule 10b-5 action. The sellers of Reg. A offerings will ignore this new reality at their private liability peril. Plaintiffs’ and defense counsel alike are going to have to dig into the vaults to unearth their 12(a)(2) memos, briefs and case law from 17 years ago and brush up on a cause of action returned from the dead.
The transactional upshot of the Reg. A changes are that this (sort of) registration exemption is likely to go from worst to first among small companies seeking capital. Just as the popularity of Rule 506 skyrocketed after the states were preempted from regulating them in 1995, it is not hard to envision a similar impact in Reg. A, especially when coupled with the 1,000% increase in the amount that can be raised. Reg. A may prove to be even more attractive and useful than Rule 506 in some circles, given that there are no investor minimum qualifications like the accredited or “sophisticated” investor restrictions in Rule 506. Much will depend on the process the SEC develops for review of the offerings. SEC examiners at Corp Fin may review the new deals “vigorously” knowing they are the only line of government defense, with the states out of the way, but they do not impose merit review requirements on the offerings.
It remains to be seen how new Reg. A offerings will be sold. Will underwriting and secondary market broker-dealers, analysts and investors have any interest in this new tier of securities? In my mind, that is the “$64,000” question (shouldn’t we lobby Congress to adjust the old “$64,000” standard for inflation? What would it be now, in today’s dollars?).