By John M. Jascob, J.D., LL.M.
The chief securities regulators from Massachusetts and Montana have failed in their challenge to the SEC’s preemption of state authority to register offerings conducted under Tier 2 of Regulation A. The D.C. Circuit Court of Appeals upheld the rule, holding that the Commission’s decision to preempt state registration of Tier 2 securities sold to “qualified purchasers” was entitled to deference under the Chevron test. The appellate panel also rejected arguments that amended Regulation A should be vacated as arbitrary and capricious because the SEC failed to explain adequately how the rule protects investors (Lindeen v. SEC, June 14, 2016, Henderson, K.).
Preemption challenge. In May 2015, Massachusetts Secretary of the Commonwealth William Galvin and Montana State Auditor Monica Lindeen filed separate 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, 2015, so-called Regulation A+ raised the dollar limit for smaller offerings that are exempt from Securities Act registration. The amendments also created two tiers of offerings under Regulation A, while preempting Tier 2 offerings of up to $50 million from state registration and qualification requirements.
The states asked the court to vacate the rule, contending that the SEC’s failure to impose any meaningful standards on the “qualified purchasers” eligible to invest in Tier 2 offerings overstepped the Commission’s authority under the JOBS Act and stripped investors of valuable state law protections. The SEC, in turn, argued that its interpretation was consistent with its JOBS Act mandate and thus satisfied the statutory construction standards enunciated by the Supreme Court in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc. (1984).
Chevron step one. After tracing the history of Regulation A from its original adoption in 1936, the appellate panel turned to the states’ contention that the SEC’s definition of “qualified purchaser” contravenes the plain meaning of the Securities Act. In the states’ view, the term “qualified purchaser” cannot mean “any person” to whom Tier 2 securities are offered or sold, but instead must limit the universe of purchasers who possess the financial resources or sophistication to invest without state law safeguards.
The appellate panel found, however, that under Securities Act Section 18, Congress explicitly authorized the Commission to define the term “qualified purchaser” and to adopt different definitions for different types of securities. Exercising this grant, the SEC concluded that all purchasers of Tier-2 securities are qualified so long as non-accredited purchasers limit their purchase to 10 per cent of their annual income or net worth. Nothing in the text of the Securities Act unambiguously foreclosed the SEC from adopting this definition, the court reasoned.
Although the petitioners argued that commonly understood definition of “qualified” meant that the SEC must in some way reduce the universe of Tier 2 purchasers from “any purchaser,” the petitioners identified no statutory provision that barred the SEC from concluding that all Tier 2 purchasers are “qualified” in view of the other investor protections built into Tier 2. Congress explicitly granted the SEC discretion to determine how best to protect public and investors, and the Commission, in exercising that discretion, concluded that Tier 2 investors are sufficiently protected by the rule’s purchase cap and reporting requirements. The SEC did not nullify the term “qualified,” but rather concluded that all Tier 2 purchasers are qualified. Accordingly, Regulation A+ does not conflict with the Congress’s unambiguous intent.
Chevron step two. Next, the appellate panel moved on to the petitioners’ argument that the definition failed Chevron step two because the SEC’s failure to impose restrictions based on investor wealth, income or sophistication was unreasonable and manifestly contrary to the statute. For all the reasons set forth in the discussion under Chevron step one, the court held that the SEC acted reasonably and within its broad definitional authority. The court rejected the contention that Chevron deference was inappropriate in the preemption context, while finding that the SEC provided a reasoned explanation for why the final rules for Regulation A would provide for a meaningful addition to the existing capital formation options of smaller companies while maintaining important investor protections.
APA review. Finally, the court disagreed with the petitioners’ claim that Regulation A+ was arbitrary and capricious in violation of the Administrative Procedure Act because the SEC offered only a single paragraph to explain why the new rule might lessen the adverse effects of blue sky preemption. The court concluded that the Commission complied with its statutory obligation by providing a reasoned analysis of how its qualified-purchaser definition strikes the appropriate balance between mitigating cost and time demands on issuers and providing investor protections. Given the JOBS Act mandate to revitalize Regulation A, the SEC concluded that the potential decrease in investor protection was balanced by the reduced costs for Tier 2 issuers and purchasers.
Although NASAA's amicus brief had faulted the SEC for relying on “little to no evidence” regarding the costs of state law compliance and state law preemption, the Commission did not have the data necessary to quantify those costs precisely because Regulation A was rarely used. The court declined to require the Commission “to measure the immeasurable,” and found that the SEC’s discussion of unquantifiable benefits fulfilled its statutory obligation to consider and evaluate potential costs and benefits. Accordingly, the petitions for review were denied.
The consolidated cases are Nos. 15-1149 and 15-1150.