Thursday, October 29, 2015

States Fire Back at SEC in Reg A+ Preemption Battle

By John M. Jascob, J.D., LL.M.

The SEC’s failure to impose any qualifications on purchasers of Regulation A securities vitiates the Commission’s attempt to preempt state authority over those offerings, two state securities commissioners have argued. In their ongoing court challenge to the rule, regulators from Massachusetts and Montana argued that the SEC’s amendments to Regulation A violate the plain meaning of the Securities Act, overstep the Commission’s delegated authority, and strip investors of valuable state law protections (Lindeen v. SEC, October 27, 2015).

The state commissioners made their arguments in their reply brief to the Court of Appeals for the D.C. Circuit. In late May, Massachusetts Secretary of the Commonwealth William Galvin and Montana State Auditor Monica Lindeen had each filed petitions with the court requesting judicial review of the legality of the Commission’s expansion of the exemptions available under Regulation A. Adopted by the SEC under the mandate of the JOBS Act on March 25, so-called Regulation A+ raises the dollar limit for smaller offerings that are exempt from Securities Act registration. The amendments also create two tiers of offerings under Regulation A while preempting Tier 2 offerings of up to $50 million from state regulation.

No qualification of purchasers. The state regulators urged the court to strike down the rule under the first step of the Chevron analysis because contrary to the expressed intent of Congress in the JOBS Act, the rule imposes no qualification on purchasers of Tier 2 securities under Regulation A. Instead, the Commission has simply defined “qualified purchaser” to mean “any person” that purchases a security in a Tier 2 offering. Although the Commission’s brief had emphasized the agency’s discretion to tailor different definitions of “qualified purchaser” based on different categories of securities, this authority does not excuse the Commission’s failure to identify the characteristics of Regulation A purchasers that make them “qualified” to invest, the state commissioners contended.

The SEC’s contention that the “qualified purchaser” requirement is satisfied by any definition that is limited in application to a particular category of securities is a patently erroneous interpretation of the law, the state regulators argued. Although acknowledging that Securities Act Section 18(b)(3) allows the Commission to vary its definitions “with respect to different categories of securities,” in all circumstances these definitions must define who is “qualified” to purchase in each category. Allowing the SEC to effectuate wholesale state preemption for different categories of securities would destroy the delicate balance of powers established in Section 18 and overturn the country’s longstanding dual system of regulatory enforcement, the state regulators contended.

The color purple. Galvin and Lindeen flatly rejected the Commission's argument that because Congress gave the SEC express authority to define a term, the Commission's definition “may diverge from the ‘ordinary meaning’ of the term.” In their view, the limited definitional authority provided by Congress does not empower the SEC to ignore the “qualified purchaser” requirement altogether. Congress gave the Commission discretion to develop different definitions of “qualified purchaser” based on “different categories of securities” at issue. That discretion did not create a license to impose no qualifications on purchasers at all, the state commissioners contended.

In their opening brief, Galvin and Lindeen had cited Justice Scalia’s observation that “[i]t does not matter whether the word ‘yellow’ is ambiguous when the agency has interpreted it to mean ‘purple.’” The Commission responded by claiming that “this is a situation where Congress instructed the Commission to choose the color.” According to the petitioners, this response truly captures the Commission’s position in the case: “Congress said “yellow” and allowed the Commission to use different shades for different circumstances; the Commission now thinks it can choose any color it wants.” Stating that the SEC’s approach unlawfully reads the “qualified purchaser” requirement out of Securities Act Sections 18(b)(3) and 18(b)(4)(D), Galvin and Lindeen urged the court to strike down the rule.

The cases are Nos. 15-1149 and 15-1150.