Regulation A+ and Blue Sky Laws: Restrictions on Secondary Trading
Jay Kaplowitz, Cass Sanford, Tessa Patti
The new and improved Regulation A – now coined “Reg A+” – has established itself as a compelling alternative to traditional capital-raising methods such as venture capital, private placements and IPOs. However, as discussed below, if secondary market liquidity is a priority, issuers thinking of conducting a Reg A+ offering must be mindful of blue sky regulations.
Regulation A was expanded in rules adopted by the SEC on March 25, 2015 and Reg A+ became effective on June 19, 2015. Reg A+ allows companies to raise up to $50M per year from accredited and non-accredited investors using general solicitation.
Reg A+ is divided into two tiers, each with its own built-in benefits. Tier I allows a company to raise up to $20M and does not require an issuer to provide audited financial statements in its Reg A+ offering circular. Tier II Issuers must provide two years of audited financials but can raise up to $50M per year and the offering is exempt from state Blue Sky registration and qualifications. The securities issued under both Tiers I and II are unrestricted and freely transferable – allowing for immediate secondary trading.
Although Tier II issuers are generally exempt from state securities law registration at the offering stage, questions remain as to how Blue Sky compliance will impact secondary trading and liquidity. Blue Sky laws are designed to protect investors against fraudulent sales practices and activities; however, the cost and delay of complying with these provisions can be debilitating to early-stage companies trying to grow their businesses.
These laws governing secondary trading typically vary from state to state with sometimes subtle, but crucial, differences. NASDAQ and NYSE listed securities are exempt from Blue Sky registration. But, OTC listed securities are typically not exempt. From a practical standpoint, it is important for a company looking to raise capital using Reg A+ and provide liquidity to its investors to plan on how it is going to facilitate secondary trading. As discussed below, the “Manual Exception” may alleviate the secondary trading issue by preempting blue sky laws in 38 states if an issuer is registered on a manual such as Standard & Poor’s.
Tier I vs. Tier II: Blue Sky Regulation of the Initial Offering
Like the traditional pre-amended Regulation A rules, Tier I offerings must comply with the individual Blue Sky laws of each state where the company plans to sell its securities. This requirement was one of the many reasons that pre-amended Regulation A was largely unused for decades and not nearly as popular as Regulation D.
Tier II, on the other hand, offers “covered securities” under the National Securities Markets Improvement Act of 1996 (“NSMIA”) and therefore are exempt from state registration and qualification requirements. States can (and generally will) still require that information provided to the SEC also be filed with the state, and that the issuer pay filing fees for the privilege. Satisfying state filing requirements is far less burdensome than full Blue Sky compliance.
Due to the considerable time and potential for delay associated with Blue Sky registration and filing, the exemption offered under Tier II is favorable even in light of the additional requirement to provide audited financials. Therefore, even if an issuer does not hit the $20M benchmark in its offering, it still may benefit from filing as a Tier II Offering.
After the Offering: Restrictions on Secondary Trading
The Blue Sky analysis becomes more complicated for both Tier I and Tier II offerings after (unrestricted) securities are issued and shareholders begin to seek liquidity.
It is important to keep in mind that Reg A+ was designed to provide necessary capital to developing businesses and startups and was not intended to provide the investor with immediate liquidity. Accordingly, secondary sales are limited in the first year following the initial offering. The aggregate secondary trading cap is limited to $6M under Tier I and $15M 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., $20M or $50M, respectively).
Typically, broker-dealers cannot recommend or give advice on a company’s stock when the company is not compliant with Blue Sky laws in the state in which the investor resides. However, Reg A+ does not neatly follow this formula. Under Tier I, all trading must be compliant with Blue Sky regulations: both the initial offering and secondary trading. 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.
Under Tier II, Blue Sky laws create a different picture. Although offerings under Tier II are exempt from state Blue Sky laws, the secondary trading of securities received by purchasers in the offering may be subject to state Blue Sky laws. Therefore, issuers of Reg A+ securities must have a secondary trading exemption in order for investors to sell their shares.
Tier II Secondary Trading Exemptions
States provide certain exemptions for non-issuer trading of a company’s securities. Under Reg A+, the exemptions of importance are the “Manual Exemption” and the exemption available for unsolicited brokerage transactions. Other secondary trading exemptions include isolated transactions, the “quality” exemption, transactions by fiduciaries and in judicial sales, and pledgee transactions. Nevertheless, these exemptions likely do not apply to secondary trading of Reg A+ Tier II securities.
Currently, 38 states recognize the Manual Exemption. 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.
The Blue Sky restrictions on secondary trading may just be temporary, SEC comments indicate as follows:
“[w]hile further preemption of state securities law regulation of the secondary trading of Regulation A securities issued in a Tier 2 offering could, as some commenters suggest, further advance the development of a national securities market by easing the compliance obligations of investors that trade in the secondary markets, we believe that the approach to preemption of state securities laws adopted today is more appropriate at the outset and will afford the Commission time to subsequently review the development of, and consider potential changes to, the final rules for primary and secondary Regulation A markets.”
Elio Motors, the first U.S. Company to complete a Reg A+ offering, did not list in a securities manual and instead relies on the unsolicited brokerage transaction exemption to trade on the OTCQX market. Elio averages over 8,000 shares traded per day at approximately $20 per share.
Conclusions on Blue Sky and Secondary Trading
Much is still to be determined as more and more companies make use of Reg A+. Despite the limited regulatory restrictions on resale, the creation of sufficient liquidity for investors continues to be a chief concern for issuers selling securities in Reg A+ offerings.
The SEC is currently facing litigation in the D.C. Circuit from Massachusetts and Montana on this very issue. Both states argue that only Congress reserves the power to preempt certain securities from Blue Sky regulations and the SEC’s authority is limited to “qualified purchasers” as previously defined (i.e., accredited investors). Without this distinction, the states believe the SEC denies meaningful protection afforded to investors through state laws. The SEC on the other hand asserts that Congress delegated its authority to define the term “qualified purchaser” and Regulation A+ has defined the term to include anyone in any amount. Further, the Commission contends the new rule puts in place other protections intended to cover the preemption of state securities’ laws.
In the meantime, investors can go to one of the alternative auction/listing websites to seek buyers for their Reg A+ holdings (e.g., ASMX, CTTauctions, CFX, and FNEX). A secondary trading right may be accomplished through the Manual Exemption or on an unsolicited basis when listed on OTCQX.
Elio Motors went through the process and expense of getting Blue Sky clearance in all states. However, the draw for issuers to use Reg A+ is, in part, its preemption from Blue Sky laws under Tier II. Whether or not a company reaches the $20 M floor for Tier II in its actual offering, the exemption remains effective. We believe that companies would benefit from utilizing the NASAA coordinated review program, the Manual Exemption, and the unsolicited brokerage transactions exemptions to ease the burden of Blue Sky and take full advantage of the amended Reg A+, Tier II program.
 National Securities Markets Improvement Act of 1996, Pub. L. No. 104-290, 110 Stat.
3416 (codified as amended in scattered sections of 15 U.S.C. (2006)).
 See 17 C.F.R. § 230.251.
 § 230.251.
 North American Securities Administrators Association, Regulation A Offerings, NASAA’s Coordinated Review Program for Regulation A Offerings, http://www.nasaa.org/industry-resources/corporation-finance/coordinated-review/regulation-a-offerings/ (last visited Apr. 12, 201).
 See § 230.251.
 Securities and Exchange Commission, Amendments for Small and Additional Issues Exemptions under the Securities Act (Regulation A), June 15, 2015, 228 no. 833.
 Monica Lindeen v. United States Securities and Exchange Commission, No. 15-1149 (D.C. Cir. April 16, 2016).
 See Lindeen, No. 15-1149; William Galvin v. United States Securities and Exchange Commission, No. 15-1150 (D.C. Cir. April 14, 2016).
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