Tuesday, March 31, 2015

Gallagher Praises New Reg A+ Framework, but Wants Further Action

[This story previously appeared in Securities Regulation Daily.]

By Amanda Maine, J.D.

SEC Commissioner Daniel M. Gallagher said that he is thrilled with the Commission’s recent adoption of changes revitalizing Regulation A (known as Regulation A+) as required by the JOBS Act. However, Gallagher believes that that the SEC can do more to encourage capital formation, especially by smaller issuers. Gallagher made his remarks at Vanderbilt Law School’s Annual Law and Business Conference.

Improvements to Regulation A. Gallagher applauded the amendments to Regulation A, noting that the cap on the size of Regulation A offerings has been raised to $50 million and that “Tier 2” issuers now escape the review process of over 50 state securities regulators. However, he warned that the SEC has its work ahead of it in order to make Regulation A+ a success. Gallagher would have preferred that the offering limit be raised to $75 million, which the SEC had authority to do under the JOBS Act.

Gallagher noted that the recent changes were designed to enhance the primary issuance of securities, but urged the SEC to explore how to invigorate Regulation A further by enhancing secondary market liquidity. Venture exchanges, Gallagher said, can be the answer to this “secondary market liquidity conundrum.” However, if the Commission does not pursue the creation of venture exchanges for smaller issuers, Gallagher observed that Congress could act to spur the Commission to take action, as it did when it passed the JOBS Act.

Gallagher also criticized the new rules as not facilitating capital formation for “Tier 1” issuers, which includes offerings of up to $20 million in a 12-month period. In addition to SEC review and qualification, Tier 1 issuers must still navigate state blue sky law qualification, he said. The increased size may help issuers that wish to raise between $5 million and $20 million, but issuers looking to raise up to $5 million should probably seek other solutions because even with the changes, for the smallest offerings Regulation A+ is too expensive and burdensome for smaller companies, according to Gallagher.

Smaller offerings. Raising under $5 million in capital should not be so hard, Gallagher said. The obvious solution is crowdfunding, which has taken off for accredited investors with the lifting of the general solicitation ban under the JOBS Act, while crowdfunding to non-accredited investors is mired in “SEC rulemaking limbo,” Gallagher lamented. He said that Rule 506(c) has given rise to a robust crowdfunding industry. Despite critics who have characterized the weakened rules as the “Wild West,” Gallagher pointed out that safeguards for investors remain in place, including that antifraud laws still apply, accredited investor verification must still be complied with, no “bad actors” can be involved, and a Form D must be filed.

In contrast to the Wild West of rule 506(c), Gallagher said that the JOBS Act Title III crowdfunding provision, which was weighed down by “nanny state investor protections,” is more akin to 1970s East Germany, where the heavy hand of the state is “omnipresent and smothering.” Even if the Title III crowdfunding provisions are adopted as proposed, Gallagher said that it is widely expected to be too burdensome for the smallest companies. In addition, Rules 504 and 505 under Regulation D are infrequently used because issuers prefer to use Rule 506 for offerings of any size, according to Gallagher.

Gallagher voiced his skepticism that the Commission would be eager, without action from Congress, to adopt his ideas for easier capital formation for smaller companies. These ideas include further segmenting small companies into “nanocap” and “microcap” bands and radically scaling reporting requirements for the smallest issuers. Even though the Commission has implemented Regulation A+, Gallagher stated he could only award it a grade of “incomplete” at this time regarding its treatment of capital formation issues.