By Matthew Garza, J.D.
The National Small Business Association has filed an amicus brief in the U.S. Court of Appeals for the D.C. Circuit supporting the preemption of state blue sky laws in “Tier 2” offerings under Regulation A+. The group said its members would bear the adverse consequences of striking the preemption provision, a result sought by the states of Montana and Massachusetts in their suit against the SEC (Lindeen v. SEC, October 13, 2015).
Rulemaking. Regulation A+, adopted in Release No. 33-9741 on March 25, created two tiers of offerings: Tier 1 offerings of up to $20 million and Tier 2 offerings of up to $50 million. While Tier 1 offerings remain subject to state regulation, Tier 2 preempts state Blue Sky laws for “qualified purchasers” and imposes additional disclosure and reporting requirements. Title IV of the JOBS Act directed the SEC to define the “qualified purchasers” that would be exempted from state oversight; the rule defines “qualified purchaser” as “any person to whom securities are offered or sold pursuant to a Tier 2 offering.”
Three days before the June 19 effective date, the SEC issued an order denying a stay of Regulation A+ sought by the state of Montana. The Commission rejected the state’s argument that the rulemaking would subject Montana issuers and “unsophisticated and unwary consumers” to irreparable harm, countering that a delay in implementation of the rule would hurt capital formation.
Legislative history. The SEC was clearly authorized by the JOBS Act to preempt state registration laws on sales to qualified purchasers, argued the NSBA. The Act was introduced with bi-partisan support to address the capital formation burdens that has resulted in a declining number of public companies, and testimony before the House alerted members that the legislation would help drive down the costs for issuers by avoiding costly state-by-state filing.
Congressman Barney Frank introduced an amendment to remove the exemption for broker-dealers, but his proposed amendment retained the same exemption for sales to qualified purchasers as defined by the Commission, the group asserted. The bill containing this language passed the House by a vote of 421 to 1 and was later added to the final bill, which passed by a vote of 390-23. “Throughout this process, Congress knew Sec. 401(b) of the JOBS Act gave the Commission unrestricted authority to define ‘qualified purchaser’ in manner that could preempt securities sold to all Tier 2 purchasers,” the group wrote in its brief.
Chevron deference. The group said Chevron deference should be afforded to the SEC’s definition of qualified purchaser because the additional burdens that would result from state registration would lead to “absurd results” not intended by Congress. The “absurd results” the NSBA envisioned was a limitation of the capital formation tool Congress intended to create, as well as a reduction in investor protection by driving businesses to seek capital under Regulation D and other private offering exemptions that are less costly, and where there is a greater opportunity for issuers to defraud investors because there is no regulatory review, fewer disclosure requirements, and no requirement to provide audited financial statements.
The group disagreed with the claim that state registration would protect investors, pointing to EDGAR data showing only 26 Regulation A offerings from 2012 to 2014, while the total number of Regulation D filings in 2014 that qualified under Regulation A exceeded 557. Increased costs of Regulation A will force issuers to use Regulation D, the NSBA argued, which cannot be advertised unless limited to accredited investors.
“The States will not be able to provide greater investor protection under Tier 2, Regulation A Offerings because empirical evidence demonstrates that issuers will use lower cost Regulation D, where there is little regulatory oversight before investor funds are taken,” the group concluded.