Securities Law Blog

Regulation A issuers may be younger, smaller and less profitable than more established Form S-1 issuers, but they must still comply with numerous specific SEC regulations governing disclosures and procedural rules during ongoing public offerings. By enforcing Regulation A rule violations against ten microcap companies, the SEC has made clear that, despite any relaxation of restrictions on these offerings, well-established SEC rules apply to Regulation A offerings as much as they do to traditional registered offerings.

On May 16, 2023, the SEC announced settlements with ten microcap companies requiring them to cease and desist from violations of the offering registration provisions of the Securities Act of 1933 (the “Securities Act”) and to pay civil penalties ranging from $5,000 to $90,000 for failing to follow basic disclosure and procedural rules with respect to their ongoing Regulation A offerings.

In each of the SEC’s ten orders, the microcap companies (companies with low or “micro” market capitalizations) had obtained qualification from the SEC for their securities offerings using Regulation A, but they subsequently made one or more fundamental changes to their offerings without meeting the conditions for a valid ongoing registration exemption.  The SEC found that these fundamental changes in the terms of ongoing offerings required that the companies first file a post-qualification amendment or new offering statement with the SEC for its review and clearance, which they failed to do.  The SEC’s orders found that such mid-offering changes to the terms included (i) improperly increasing the number of shares offered, (ii) improperly increasing or decreasing the price of shares offered, (iii) failing to file updated financial statements at least annually for ongoing offerings, (iv) engaging in prohibited at the market offerings and (v) engaging in prohibited delayed offerings. As a result, each of the microcap companies offered and sold securities while there was no valid Regulation A registration exemption for the offering, resulting in a violation of the federal securities laws. 

Regulation A and Traditional Registered Offerings

In 2012, Regulation A offerings were revamped under the Jumpstart Our Business Startups Act (the “JOBS Act”).  As with other provisions of the JOBS Act, Regulation A was designed to be used as a potential source of early-stage financing for small businesses.  Its regulatory framework for securities offerings, found in Securities Act Rules 251 to 263, allowed small businesses to offer and sell securities to the public with fewer requirements for registering an offering with the SEC, while also protecting investors.

Regulation A offerings differ from traditional initial public offerings (“IPOs”) registered on a Form S-1 registration statement.  Regulation A is a limited exemption from registration under the Securities Act utilizing a Form 1-A offering statement as its primary disclosure document.  Rather than being conducted as a traditional registered firm commitment underwriting with underwriters that closes after the registration statement is declared effective, the roadshow is completed and the money has been raised, a Regulation A offering is typically structured as a best efforts offering and frequently conducted on a crowdfunding platform without an underwriter or participating broker-dealer. The Regulation A offering only commences when it is “qualified” by the SEC and often involves multiple closings over a period of more than one year. In some sense, the offering period effectively serves as the Regulation A offering’s long roadshow as issuers frequently make changes to the offering terms to improve the likelihood of a successful offering based on the demands of potential investors.  

From an SEC filing perspective, there are similarities in the terminology between traditional IPOs and Regulation A offerings: (a) a traditional IPO “registration statement” is akin to a Regulation A “offering statement,” (b) a traditional IPO “prospectus” is akin to a Regulation A “offering circular,” (c) the SEC clears a registration statement by declaring it “effective,” while it clears an offering statement by declaring it “qualified” and (d) a supplement (or “sticker”) can be used for either a prospectus or an offering circular to provide clarifying information.

For both a traditional registered offering and a Regulation A offering, the Securities Act requires a high degree of specificity in the terms of the offering.  A change in a fundamental term of an offering is in effect a termination of the offering as originally made, and requires the issuer to file a post-effective or -qualified amendment, or a new registration or offering statement with the SEC prior to any further sales, reflecting the modified terms and their impact on disclosures in each applicable section of the disclosure document and, in particular, the use of proceeds section when there are changes in the offering size and price. Regulation A issuers and their professional advisers, such as lawyers, accountants, broker-dealers and trading platforms, appear to be overlooking well-established rules for public offerings that require relevant and timely disclosure to investors of fundamental changes during the course of an offering.  

The SEC Orders and Rule Violations

In the ten separate orders made public by the SEC, the SEC found violations by each of the ten Regulation A issuers of key Regulation A rules in the context of changing the offering size, price or other terms of their ongoing Regulation A offerings. The concepts covered by these rules have been generally applicable to issuers in traditional registered offerings, including shelf registrations, for many years pursuant to similar provisions of the Securities Act.

Increasing the Number of Shares Offered

Securities Act Rules 252(e) and 253(b):  An issuer is not permitted to use an offering circular supplement to increase the number of securities offered under Regulation A. Additional securities may be offered only pursuant to a new offering statement or a post-qualification amendment qualified by the SEC.  The note to Section 253 reads: “An offering circular supplement may not be used to increase the volume of securities being offered. Additional securities may only be offered pursuant to a new offering statement or post-qualification amendment qualified by the Commission.”

The SEC found that, because many of the microcap companies increased the number of securities offered by merely filing an offering circular supplement on Form 253G2 and did not file a new offering statement or post-qualification amendment that was reviewed and qualified by the SEC, they offered and sold securities in contravention of the requirement that qualification is a necessary component for Regulation A sales.  In several instances noted in the SEC orders, the companies sought to increase the number of securities offered by more than doubling the original number disclosed in the qualified offering statement.  As a result, Regulation A did not apply to the offers and sales made after the filing of the prior supplement improperly increasing the number of shares offered.

Decreasing the Price of Shares Offered

Securities Act Rules 252(e) and 252(f)(2)(ii):  An issuer is not permitted to use an offering circular supplement to fundamentally change the information set forth in the offering statement.  Instead, such changes require a new offering statement or a post-qualification amendment, each of which must be qualified by the SEC.  A fundamental change may be present when an issuer changes the price of securities offered under Regulation A from the qualified offering price.

The SEC found that, because the change to the offering price of the shares of the microcap companies from the qualified offering price was a fundamental change, being significantly more than 20% below the qualified offering price provided in the offering statement, a new offering statement or post-qualification amendment reviewed and qualified by the SEC was required. In one instance noted in the SEC orders, the company decreased the offering price by 80% and four months later decreased the offering price by another 58%, in each case using an offering circular supplement.  In a similar instance in another order, the company lowered the offering price by more than 50% and again two months later by an additional 80% without a new offering statement or post-qualification amendment. As these and other companies did not file either new offering statements or post-qualification amendments, but filed just a supplement instead, they offered and sold securities in contravention of the requirement that qualification is a necessary component for Regulation A sales.  As a result, Regulation A did not apply to the offers and sales made after the filing of the companies’ supplements to decrease the offering price.

Failing to File Updated Financial Statements

Securities Act Rule 252(f)(2)(i):  To conduct an ongoing offering, an issuer is required to file a post-qualification amendment at least every 12 months after the qualification date to include the financial statements for the most recent period that would be required by Form 1-A.

The SEC found that, because several of the companies did not file a post-qualification amendment on Form 1-A/A to update their financial statements by the end of the 12-month period after the SEC qualified their offering statement, they failed to comply with this rule by making sales when the companies were not current with their periodic financial statements.  Regulation A rules require the filing of both an annual report on Form 1-K containing audited financial statements and, if the offering is still ongoing, a post-qualification amendment, but permits incorporation by reference of the financial statements required in the post-qualification amendment to a previously filed Form 1-K.  As a result of not filing the post-qualification amendment when required, Regulation A did not apply to any offers and sales made after the end of the 12-month period after qualification.

Prohibiting At the Market Offerings

Securities Act Rule 251(d)(3)(ii):  An issuer is not permitted to conduct an “at the market offering” under Regulation A.  An at the market offering is defined in Regulation A as an “offering of equity securities into an existing trading market for outstanding shares of the same class at other than a fixed price.”

The SEC found that some companies failed to comply with Regulation A’s requirement that an offering occur at a fixed price when they lowered the offering price of their shares multiple times apparently in parallel with the over-the-counter quoted market price of the shares on or near the date of the supplement decreasing the offering price, or otherwise simultaneously offered shares at different prices from supplement to supplement.  As a result, Regulation A did not apply to the offers and sales made in the offering subsequent to the filing of the supplement decreasing the offering price.

Prohibiting Delayed Offerings

Securities Act Rule 251(d)(3)(i)(F):  To properly engage in a continuous offering of securities, an issuer must fix the price of and commence the offering “within two calendar days of the qualification date.”  

The SEC found that some companies engaged in an impermissible delayed offering of securities because they did not fix the price of and commence their offering within two calendar days. In certain instances noted in the SEC orders, the companies had disclosed upon qualification a range of offering prices, but did not fix the price before making sales until more than a month and a half after qualification.  As a result, Regulation A was not available to their offerings.

Conclusion

Microcap companies should be mindful that inattention to or confusion by the Regulation A legal framework, inexperience with how Regulation A offerings work, inability to absorb the incremental costs of an ongoing offering or unwillingness to temporarily “pause” sales of securities to the public to comply with these detailed procedural rules could lead to a securities offering violation and a blemish on the company’s record.  While one can argue that these requirements for microcap companies are unduly burdensome in an imperfect system and undermine Congress’s intent in authorizing Regulation A to “help small companies gain access to capital markets without the costs and delays associated with the full-scale securities registration process,” the SEC has made clear the necessity for these rules.