For decades, the Holy Grail for federal legislators has been to develop legislation to stimulate small business growth while finding the balance between too much regulation and too little oversight. While many might compare this quest to a Monty Python sketch, the recently passed, bipartisan Jumpstart Our Business Startups Act (JOBS Act) may do just that by empowering regional investment in businesses across the country.

On April 5, 2012, President Obama signed the JOBS Act, into law. Easy to grasp and more controversial provisions such as crowdfunding or the IPO onramp received the lion's share of attention; however the sweeping amendments to the exemption from public registration under "Regulation A" will mean new and exciting opportunities for financial advisors, investors and issuers in the immediate future.

What is Regulation A and how has it changed?

Regulation A under the Securities Act of 1933, as amended, dates to the 1930s and is promulgated under Section 3(b) of the securities act, which generally permits the Securities and Exchange Commission to exempt classes of securities from registration, so long as the aggregate dollar amount of such securities issued pursuant to a Section 3(b) exemption does not exceed $5 million in any one year. It is important to understand that Regulation A exempts the securities themselves from registration, whereas Regulation D for private offerings only exempts the issuing transaction for securities issued under the exemption, and then only if the manner in which the private offering is conducted complies with Regulation D. Moreover, unlike Regulation A, the availability of Regulation D to insulate the issuer and its offering from the registration requirements of the securities act is dependent on the type of investor purchasing in the offering, and the issuer and the investor complying with significant restrictions on the transfer of the securities purchased.

In short, Regulation A has three significant advantages:

(i) Public solicitation in a Regulation A offering is permitted;

(ii) Securities offered under Regulation A may be offered and sold to non-accredited investors; and

(iii) Securities purchased in a Regulation A offering may be freely traded by investors.

Prior to the JOBS Act, Regulation A failed to gain much attention because of its limitation to $5 million in a 12-month period. The JOBS Act directs the SEC to increase the amount of securities to be sold by an issuer in a 12-month period under Regulation A from $5 million to $50 million.  

This will have a profound impact on financial advisors and their clients by providing investment options beyond either highly illiquid, private Regulation D transactions, or the volatility of Wall Street.  

The JOBS Act also revises Regulation A by mandating the issuer of securities to file audited financials annually. Title IV requires the SEC to establish electronic filing for Regulations A, and directs the SEC to consider other periodic disclosures.  

But how does this impact financial professionals?

1) Liquidity

For many financial advisors and investors, Regulation D has become a dirty word. The chief reason is that these securities are highly illiquid both from a legal and a market perspective.  

Legally, an investor cannot resell securities without either registering them under the 1933 securities act or finding an exemption from registration. This takes time and adds cost.

From a market perspective, there is no efficient way to put sellers with buyers when liquidity is needed. Even when an exemption to registration is available, pricing is problematic because there is little or no information concerning the issuer or the securities available to the public.  

It comes as no news to many readers that the illiquidity of these securities have forced many investors in this economy to ride failing investments indefinitely. That has resulted in an upswing in arbitrations related to Regulation D investments, causing errors and omission insurers to no longer cover or otherwise discourage activities related to selling restricted securities.

Expanded Regulation A not only provides for legal liquidity but further requires filing with the SEC audited, annual financials of the issuers, thus, providing a baseline of information for buyers and advisors. The law also directs the SEC to consider other periodic reporting measures that will enhance transparency over time. SEC staff have want to work with the financial community to provide periodic reporting that will be meaningful to the market without violating the legislative intent to keep the requirements of Regulation A manageable.

Legal liquidity and transparency leads to efficiencies that build secondary markets and REAL liquidity.

2) Investment Options

In theory, Wall Street has always been available to American businesses of any size to form capital. In practice, and for a host of reasons related to the expense and regulatory burden that has grown exponentially in the past two decades around IPOs, only the largest companies have had access to Wall Street.

For most issuers capital market access has been limited to the private placement of debt or equity with certain individuals and private fund investors who are willing to agree to significant restrictions on the resale of these securities. To buy these securities, investors must be limited in number or meet significant net worth or earnings thresholds to be classified as "accredited investors."  The end result is that the variety of investment options and the audience to which those options were made available have been severely limited.

Expanded Regulation A now gives a much broader variety of issuers and businesses the ability to offer their securities to a much broader segment of the population. As such, financial advisors will have far greater opportunities to find unique and quality investments for their clientele and recruit new clients by offering the same.  

Restrictions on the manner of solicitation have typically meant that businesses face a very inefficient raise process.  That meant going primarily to individual or institutional investors that could take down investments in large increments, and, more to the point, restrictions on liquidity has been translated into demands by these investors for big returns on riskier investments.    

However, under Regulation A, there is the opportunity for many mid-market and lower mid-market companies, for example, that have solid fundamentals, the ability to consistently produce dividends or potentially be a lucrative acquisition target in the future, to reach a much broader segment of the population with performance goals that are realistic and achievable.  Furthermore, many of these opportunities could potentially be in the investors" "backyard" further lending to the notion of transparency and knowledgeable investing.   

That should afford the opportunity for many smaller and regional investment banks to be able to bring to market unique products, public in nature, as compared with what most investors can obtain from Wall Street.  Further, the size of these deals would likely not attract the large, Wall Street banks, making this a unique, niche play for "Main Street" securities dealers.

How does it work?

An offering under Regulation A requires that the issuer file the Regulation A Offering Circular Form 1-A with the SEC. The SEC will review the form for adequacy of disclosure and compliance with the regulation. They will then have the opportunity to comment on the offering and request amendments to the disclosure.

While this is analogous to the registration process for public companies, this is a much more abbreviated process than public registration with less onerous rules. That equates to less expense. Where an issuer would easily be looking at anywhere from the high-six figures to several million dollars in expense to "go IPO," most Regulation A deals would likely incur somewhere in the range of $100,000 to $200,000 of costs.

It should be noted that securities sold in Regulation A offerings are subject to state securities (Blue Sky) requirements in those states wherein the offering is made or the securities are sold. Therefore, issuers and their placement agents must think tactically about the states in which the offering will be made in order to keep distribution and compliance costs within reason.

 

In addition, Finra treats Regulation A offerings like any other public securities offering, and it requires underwriters and dealer managers to submit the offering to the Rule 5122 review process prior to making sales.      

The expansions and revisions to Regulation A by the JOBS Act translate into the possibility of an entirely new form of public securities market to develop that would provide diversity and opportunities for growth in investor portfolios and businesses alike.

Robert R. Kaplan, Jr. is a founding partner at Kaplan Voekler Cunningham & Frank (KVCF).  KVCF is a multicity, boutique law firm that focuses on capital formation and compliance with an emphasis on emerging to mid-market clients and alternative investments.  He can be contacted at [email protected]