SEC Regulation A+, ICOs and Small Business Capital Formation: For Whom the Bells Toll?

[Originally Published in Crowdfund Insider on May 30, 2018]

If the Wall Street Journal is any indicator, so called Regulation A+ offerings, which sprung to life in June 2015, courtesy of Title IV of the Jumpstart Our Business Startups Act of 2012 (the JOBS Act) and SEC rulemaking,  are (or should be) all but dead.

A series of articles penned by the WSJ in 2018 noted that only  a handful of offerings under Regulation A+ have garnered the interest of the broker-dealer community (as opposed to self-underwritten offerings), and it seems that all of these are trading lower than their initial offering price. So far, the WSJ concludes, not a good bet for investors.

Over the past few years many have touted the benefits of the new Regulation A+ as a “mini-ipo”, allowing private (non-SEC reporting) companies to raise up to $50 million annually from both accredited and non-accredited investors, receiving freely tradable securities under federal law, unlike Regulation D, which has a six or 12 month holding period.

The catch: the issuer would need to have the offering “qualified” by the SEC, which meant filing a short form registration statement with the SEC and undergoing an SEC review process.  And if the offering was successful, unlike Regulation D, an issuer would then have to file annual, semi-annual, and interim reports with the SEC, but with much lighter disclosure obligations than a “fully reporting” company.

A Growing Consensus – The Regulation A+ Glass is Only Half Full

But if the opinions of small business stakeholders on Main Street are any indicator, the Regulation A+ glass is only half full, at least according to the overwhelming consensus of participants in the SEC’s 2017 Annual Government-Small Business Forum.

Also in accord, the opinions of Congress and the U.S. Treasury Department. And most recently, as discussed below, a newly formed trade association, Institute for Blockchain Innovation has weighed in on the benefit of utilizing Regulation A+ for offering freely tradable blockchain-based securities to both accredited and non-accredited investors.

So if the proverbial bells are tolling, they are tolling not for Regulation A+, but rather for the seeming complacency of the Commission – dragging its feet when it comes to any expansion of the use of Regulation A – and with less than the expected transparency.

You see, at the SEC’s 2017 SEC Annual Government-Business Forum on Small Business Capital Formation the participants ranked, in order of importance, 20 issues regarding small business capital formation, for further consideration by the SEC.

Number two in the ranking comprised six subparts, each addressing suggested future rulemaking by the SEC intended to enhance the operation of Regulation A+.  One of these recommendations: increasing the $50 million offering limit to $75 million; and a second proposal – to expand the use of Regulation A+ to all companies, reporting and non-reporting, not only private, non-reporting companies.

Six months later, there are no signs that the SEC is preparing to act on any of these recommendations. Indeed, one of these recommendations, that the $50 million offering ceiling be raised to $75 million, was expressly rejected by three of the five members of the Commission in April 2018 in a thus far unpublished letter to the Senate Banking Committee.

Under Title IV of the 2012 JOBS Act, the initial $50 million offering limit was set by Congress, but Congress also directed the SEC to review this ceiling every two years – with no upper limit set in the original law. Six years later the Commission has declined to increase this limit.

This latest failure of the Commission to act did not go unnoticed by two of the five Commissioners. In an unusual public communication, two of the five Commissioners, Hester Peirce and Michael Piwowar, in a letter penned to the Senate Banking Committee, called for their fellow Commissioners to give further consideration to increasing the $50 million annual limit:

“We share the views that animated the Treasury Report’s recommendation that the Tier 2 offering limit be increased to $75 million. Indeed, we also share this perspective with the bipartisan group of 246 members of the House of Representatives that recently passed the Regulation A+ Improvement Act of 2017 (H.R. 4263), which similarly called for an increase of the limit to $75 million.”

They further stated:

“As Commissioners of an independent regulatory agency, calibrating an appropriate Tier 2 limit is a matter for rigorous analysis via the standard notice and comment rulemaking process, conducted in full compliance with the Administrative Procedure Act. That said, the undersigned are persuaded that the time to commence that careful study is now, not when the kicked can comes to rest a couple of years down the road.”

Regulation A+ – Congress Lights a Fire Under the SEC

And in a little noticed piece of legislation signed into law in May 2018, Congress directed the SEC to amend its rules to allow both reporting and non-reporting companies to utilize Regulation A+, something allowed under the JOBS Act, but foreclosed by the SEC in subsequent rulemaking.

This small legislative change could prove to be significant to reporting companies whose shares trade on the over-the-counter markets, such as The OTC Market, versus a national exchange such as Nasdaq or the NYSE.

Once the SEC implements this new law, a reporting company which trades on the OTC market will be able to utilize Regulation A+ to reach an unlimited number of non-accredited investors outside of a fully registered offering – and without being subject to state Blue Sky laws.

Prior to this change, OTC companies would not only be barred from using Regulation A+, but if they wanted to reach more than 35 non-accredited investors in an offering, they would have to register the offering with the SEC. And unlike their peers who are trading on a national exchange, even in a fully SEC registered offering a non-exchange listed company would still need to navigate the labyrinth of state Blue Sky laws – as current law only exempts exchange listed companies from complying with state Blue Sky laws.

So by Congress passing this law, for the first time smaller reporting companies will not only have access to the Regulation A+ exempt offering process, allowing them to reach an unlimited number of non-accredited investors – without conducting a fully registered offering – they will also be able to do so and without complying with state Blue Sky laws – something they are still required to do in a fully registered offering.

And How About the SEC Raising that $50 Million Offering Limit?

So what’s behind the Commission’s refusal to even consider acting on an increase to the $50 million ceiling – six years after the passage of the JOBS Act? It’s not for a lack of credible support: apart from the very recent views of Commissioners Peirce and Piwowar, former SEC Commissioner Dan Gallagher called for an increase of the $50 million limit to $75 million or $100 million when he was a Commissioner back in September 2014, before Regulation A+ was enacted by the SEC, in an address delivered at The Heritage Foundation, entitled “What Ever Happened to Promoting Small Business Capital Formation?

Perhaps part or all of the answer for the continuing delay in even considering an increase to the Regulation A+ offering limit lies in a three letter acronym: ICO – initial coin offering – the letters that have struck fear in the hearts of many government regulators worldwide over the past two years.

You see, since July 2017 the SEC has, understandably, done a full court press (aka “fire and fury”) to force would be ICO issuers to either register their coins, or tokens, as securities, or to sell them under one of the available exemptions from registration.

Thus far, some token issuers have taken their offering off shore to friendlier (or less hostile) jurisdictions. Those in the US have continued to rely on an exemption from registration, Regulation D, which does not require SEC review, has no limitation on offering amount, but restricts the pool of US purchasers to “accredited investors.” 

The open question, however, for would be ICO issuers is how to expand the circle of token purchasers outside the circle of an estimated 8 million US accredited investors – to include the tens of millions of non-accredited US investors – and provide immediately free trading digital securities.

Enter the JCO – The Hybrid Regulation A+ “JOBS Crypto Offering”

The answer proposed by a recently formed trade association, Institute for Blockchain Innovation, boasting 60 industry members including Indiegogo, Finova, and 500 Startups, is the “JCO” – “JOBS Crypto Offering.”

The so called JCO is essentially a two-step process, whereby an issuer first conducts an offering to accredited investors under Regulation D, and then follows this with either a Regulation A+ offering or a fully registered offering.  This second step allows an issuer to include non-accredited investors in the offering. More importantly, by utilizing Regulation A+, or a fully registered offering, the investors will receive securities (e.g. tokens) available for immediate resale under federal law, compared to the 12 month holding period under Regulation D for private company offerings.  And it is widely anticipated that a secondary marketplace, dedicated to blockchain based securities, aka digital securities, will be operational later this year under the auspices of tZero, a subsidiary of Overstock.com.  Others are expected to follow tZero’s lead.

Perhaps there were some at the Commission who not only saw the same path for compliant token offerings – utilizing Regulation A+ – but also cringed at the thought of expanding the potential offering size from the current $50 million to $75 million or $100 million, as many have suggested – especially in the wake of extremely high risk, and in some cases fraudulent offerings that have characterized the ICO marketplace.  Perhaps there were some at the Commission who also perceived that their plate was already overflowing with an onslaught of SEC enforcement actions directed at non-compliant and fraudulent “coin” offerings.

This is, of course, speculation, but there is other foot dragging at the Commission level which lends credence to a real concern that the voice of small business is being ignored by the Commission, even in the face of Congressional mandates.

And What Ever Happened to the SEC Office of Small Business Advocate?

In December 2016 then President Obama signed into law a bill, entitled the SEC Small Business Advocate Act of 2016, approved unanimously by both houses of Congress, with the support of the U.S. Chamber of Commerce and the National Venture Capital Association, among others.  The bill directed the SEC to establish an independent Office of Small Business Advocate, reporting directly to Congress, a proposal that was first publicly advocated in February 2014 in my article on Crowdfund Insider, and later publicly championed by former SEC Commissioner Dan Gallagher.

Also placed under the umbrella of this new Office would be the SEC’s Small Business Capital Formation Advisory Committee, something that had operated on an ad hoc basis in the past, now codified into law.

Largely patterned after a similar law, part of the Dodd-Frank Act of 2010, which established an Office of Investor Advocate at the SEC to protect the interest of investors, the SEC Small Business Advocate Act of 2016 was intended to provide small business with a dedicated, independent voice to advocate for issues involving small business capital formation.

So where is the SEC’s Small Business Advocate today?

Though the SEC publicly cast a broad net for potential applicants back in the fall of 2017, with the application window closing in October 2017, to date there have been no formal pronouncements by the Commission on the status of this new office.  Adding to the mix, the SEC’s Small Business Capital Formation Advisory Committee was dissolved in September 2017, awaiting its reconstitution under the auspices of the new Office of Small Business Advocate.

And what does the SEC’s Chairman, Jay Clayton publicly have to say about all this? Not much – at least since his remarks on November 30, 2017 at the SEC’s Annual Government Small Business Forum:

“Additionally, we are taking steps to fill the position of the Advocate to head the Commission’s new Office of the Advocate for Small Business Capital Formation. The Advocate will be a powerful voice for small businesses across the country, providing assistance, conducting outreach to better understand their concerns and recommending improvements to the regulatory environment. The Advocate also will be responsible for organizing this annual Forum and will become a member of our Small Business Capital Formation Advisory Committee. I anticipate that the Commission will select the Advocate in the near future.”

Six months later – only crickets – not even bells tolling. No Office of the Advocate for Small Business Capital Formation – no Small Business Capital Formation Advisory Committee.

Meanwhile, many issues that could benefit from an independent advocate, not to mention an independent advisory committee, such as expanding Regulation A+ or focusing on an appropriate regulatory framework for blockchain-based securities – are seemingly being “kicked” down the road.

So, most respectfully, perhaps it is high time for the Commission to reconsider its priorities – and address the question posed by then SEC Commissioner Dan Gallagher back in September 2014: “What Ever Happened to Small Business Capital Formation?”


 

Samuel S. Guzik, a Senior Contributor to Crowdfund Insider,  is a corporate and securities attorney and business advisor with the law firm of Guzik & Associates, with more than 30 years of experience in private practice.  Guzik is also former President and Board Chair of the Crowdfunding Professional Association (CfPA) and CfPA Legislative & Regulatory Special Counsel. A nationally recognized authority on the JOBS Act, including Regulation D private placements, investment crowdfunding and Regulation A+, he is and an advisor to legislators, researchers and private businesses, including crowdfunding issuers, service providers and platforms, on matters relating to the JOBS Act. As an advocate for small and medium sized business, he has engaged with major stakeholders in the ongoing post-JOBS Act reform, including legislators, industry advocates and federal and state securities regulators. His articles on JOBS Act issues, including two published in the Harvard Law School Forum on Corporate Governance and Financial Regulation, have also served as a basis for post-JOBS Act proposed legislation

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