Reg "A" Blue sky for Tier 1

Reg "A" Blue sky for Tier 1

This memo focuses on Reg A+. Tier 1 opportunities for OTC shell companies.

Tier 1 offerings under Reg A+ have to comply with Blue Sky laws when selling the securities; Tier 2 does not and the state can only require the company to file a Form D. No state review for Tier 2 offerings.

The new Reg A+ opens new vistas in corporate development. We believe that there are new opportunities to resuscitate OTC non-reporting shell companies as well as new ways to cheaply raise seed capital.

First, it is important to understand the function of the state securities laws, the "Blue Sky" laws. When you offer new securities you must comply with both the federal and the state laws and rules.

Reg A+ has two tiers, Tier I and Tier 2. Tier 1 allows you to raise up to $20 million, while Tier 2 allows you to raise up to $50 million.

Tier 1 companies need not file audited financial statements unless they have a suitable audit for other purposes.

Tier 2 companies must file audits.

Companies with publicly trading stock must also register with state securities regulators.

Make sure you understand you must comply with Blue Sky laws to sell stock in the public offering.

You must also comply with Blue Sky laws if your stock is trading.

Tier I Blue Sky

Secondary sales are sales by existing shareholders. For example, the CEO of a company owns 30 million shares. If he sells some of those shares into the market or as part of an offering, he is making a secondary sale. By comparison, a primary sale is a sale by the company issuing new stock to investors.

Secondary sales, which would be sales by existing shareholders, are limited in the first year following the initial offering. The aggregate secondary trading cap is limited to $6 million under Tier I and $15 million under Tier II.

The new rules also provide different limitations on secondary sales for affiliates of the issuer. Secondary sales by Affiliates may not account for more than 30% of the total dollar amount of the Regulation A+ offering. This limitation, the SEC anticipates, will allow secondary sales to be made in conjunction with capital raising events by the issuer. After the first year expires, secondary sales by non-affiliates will not be limited except by the maximum offering amount permitted by either Tier I or Tier II (i.e., $20 million or $50 million, respectively).

Tier

Tier 1 can offer stock in certain states, complying with those rules in the states they select, or they can use a new program whereby 46 states coordinate review of the offering.

Companies using Tier I may take advantage of the coordinated review program launched by the North American Securities Administrators Association ("NASAA"). The coordinated review program is operational and effective in 46 states. Under this program, Tier I issuers may email their Regulation A materials to the administrator of the review program. Once approved, the offering is compliant with all participating states' laws. This process estimates a turnaround of 21 business days from the date an issuer files its offering statement until it receives comments from the states.

You do not have to elect to be reviewed by all 46 states, which would incur a lot of fees. You can pick and choose. You may want to focus your sales efforts. Generally, you would want to avoid states with "Merit Review."

Merit Review

Merit review is a pain in the neck.

Common merit review provisions relate to the following matters:

  • "Cheap stock" -- limiting sales of stock to insiders and promoters that are proximate to the offering at a significantly discounted price.

  • Loans to and other affiliate transactions -- requiring all insider loans to be repaid before the public offering; other material transactions must         be on similar terms available from unaffiliated third parties and be ratified by a majority of the independent directors;

  • Debt securities -- requiring cash flow in the past fiscal year that is sufficient to cover fixed charges, meet debt obligations as they become due         and service the debt being offered; requiring a trust indenture meeting the requirements of the Trust Indenture Act of 1939; requiring the         establishment of a sinking fund or other redemption requirements;

  • Impoundment of proceeds -- subjecting the proceeds from any offering (especially best efforts and minimum/maximum offerings) to impound;

  • Options and warrants -- limiting stock underlying such securities, at the time of the public offering, to, for example, 15 percent of the         outstanding common stock; dictating terms of exercisability to not less than 85 percent of fair market value of the underlying common stock on         the date of grant; and limiting underwriters compensatory issuances;

  • Preferred stock -- requiring net income in the past fiscal year that is sufficient to cover fixed charges, preferred stock dividends and redemption         requirements of the preferred stock being offered; and requiring the establishment of redemption provisions;

  • Promoters' equity investment -- with respect to development stage companies, requiring the promoters' equity interest to be more than 10         percent of the aggregate public offering;

  • Promotional shares -- requiring the escrow of shares or the reduction of the offering price where equity securities of a development stage         company have been issued to promoters for a value of less than 85 percent of the proposed public offering price;

  • Selling expenses and selling security holders -- limiting expenses to a percentage of the offering amount; requiring selling security holders to         pay a pro rata share of the additional expenses due to the inclusion of their shares in the public offering;

  • Unequal voting rights -- prohibiting these, unless accompanied by preferential dividend or liquidation provisions;

  • Capitalization requirements -- prohibiting the issuance of any security except common equity where the issuer is "unseasoned"; and

Specifying offering price -- requiring such prices to relate to book value, earnings history and/or industry price/earnings multiples where there is no established market for the security; requiring the price to be no lower than, e.g., $2 in any event, or no more than 25 times earnings; and forbidding certain types of offerings such as ones with a planned "step-up" pricing mechanism.

Few promotional companies can survive state merit review. They will likely choose states without merit review.

Already Trading Stock

For already trading stock, the issuer can use the "manual exemption." The "Manual Exception" helps companies with secondary trading compliance by preempting blue sky laws in 38 states if an issuer is registered on a manual such as Standard & Poor's.

To claim the exemption, the issuer and the security must be listed in a securities manual recognized by the relevant state. It must typically disclose:

  • The names of the issuer and its officers and directors,
  • The issuer's balance sheet; and
  • A profit and loss statement for either the fiscal year preceding the balance sheet or for the most recent fiscal year of operations.


Unsolicited Brokerage Transactions

Holders of Reg A+ securities may also rely on the exemption for unsolicited brokerage transactions, which allows a non-issuer transaction by or through a broker-dealer effecting an unsolicited order or offer to purchase to be exempt. It is important to note that an unsolicited transaction by or through the issuer directly would not be exempt.

Summary and Action Recommendations

Let us assume you have a non-reporting OTC shell company.

If you activate the company by reverse merging with an operating company, you can do a Tier 1 offering that includes selling shareholders.

Note that having been a shell company your shareholders cannot use Rule 144 to sell their restricted stock. This also makes it more difficult to sell stock privately to investors as they have no exit strategy. This makes Reg A+ an excellent solution as you can now register their stock for sale.

Tier 1 offerings have to comply with state securities laws and rules. You can use the Coordinated Review Program to offer in up to 46 states.

You can use the Manual Exemption to qualify in up to 38 states for secondary market trading.

NASAA's Coordinated Review Program for Regulation A Offerings

The following is from NASAA, the North American Securities Administrators Association:



Overview

The Coordinated Review Program for Regulation A Offerings is designed to facilitate the filing of Regulation A offerings in multiple U.S. jurisdictions. As more fully explained in the review protocol, a filer completes the Form CR-3(b) and submits it together with the Form 1-A and exhibits to Washington State by email. Filers should use the following email address when submitting registration materials: securitiesregistration@dfi.wa.gov. Filing fees should be mailed separately to each U.S. jurisdiction in which the issuer is seeking registration. The issuer's name should be noted on the check, or the issuer may include a copy of the first page of the Form 1-A to identify the offering for which the fee is being submitted.

Pursuant to the review protocol, a lead merit and a lead disclosure examiner will be appointed to manage the review of the offering. If the issuer is not applying for registration in a state that applies merit standards, then only a lead disclosure examiner will be appointed. The participating jurisdictions will use the applicable NASAA statements of policy as modified by the review protocol. The review protocol provides relief from the statements of policy as follows:



The lead examiners will have primary responsibility for coordinating the preparation of a comment letter outlining any deficiencies in the materials filed. The review protocol has specific timeframes for the review of the offering materials and an expedited schedule for completion of the initial comment letter. If there are no deficiencies, the lead examiner(s) will clear the offering within 21 business days of filing. Further, an issuer's response to comments will be reviewed within five (5) business days of receipt. Issuers should direct their responses to comment letters and any questions to the lead examiner(s). Issuers are encouraged to respond to the comments in a timely manner in order to help facilitate a timely registration of the offering.

Other Resources

The full list of NASAA's Statements of Policy and the contents of each policy are available here.

Small Business and the SEC (contains information about Regulation A).