Securities Regulation: Factors That May Affect Trends in Regulation A Offerings
Published: 2012-07-03T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Businesses seeking to use public offerings of securities to raise capital must comply with federal and state securities laws. Businesses must register offerings with SEC unless they qualify for an exemption. Regulation A exempts a securities offering that does not exceed $5 million from SEC registration if certain requirements are met. However, businesses still must file an offering statement that includes an offering circular and financial statements with SEC, and SEC staff review filings for consistency with applicable rules and accounting standards. In addition, Regulation A does not exempt offerings from states registration requirements, which are also intended to protect investors. Concerned about the decline in the number of public offerings, the JOBS Act requires SEC to amend Regulation A (or to adopt a new regulation) to raise the threshold for use of that registration exemption from $5 million to $50 million, and requires GAO to study the impact of state securities laws on Regulation A offerings. This report examines (1) trends in Regulation A filings, (2) how states register Regulation A filings, and, (3) factors affecting the number of Regulation A filings and how the number of filings may change in the future. GAO analyzed SEC data related to financial regulatory filings, reviewed published research, and interviewed academics, SEC staff, state securities regulators, and small businesses. SEC and NASAA provided technical comments on a draft copy of this report, which GAO incorporated as appropriate. In its letter, NASAA concurred with our finding that multiple factors have influenced the use of Regulation A.
section_title: What GAO Found
paragraphs: The number of Regulation A offerings filed and qualified (that is, cleared) by the Securities and Exchange Commission (SEC) has declined significantly after peaking in fiscal years 1997 and 1998, respectively. In particular, offerings filed since 1997 decreased from 116 in 1997 to 19 in 2011. Similarly, the number of qualified offerings dropped from 57 in 1998 to 1 in 2011. Securities attorneys GAO interviewed suggested that the decrease in filings after 1997 could be attributed to a number of factors, including the increased attractiveness of Regulation D. The National Securities Markets Improvement Act of 1996 preempted state registration requirements for other categories of securities including certain Regulation D offerings, which are also exempt from SEC registration. In contrast, Regulation A offerings are generally subject to state securities laws and must go through a federal filing and review process. In recent years, businesses have used Regulation D and registered public offerings to a greater extent than Regulation A.
States methods for registering and reviewing securities vary. One method used by states is registration by qualification, which is similar to registering securities with SEC, as issuers are required to submit certain documents to the responsible state securities agency for review and approval. All states conduct disclosure reviews of the Regulation A offerings, meaning that they ensure that all material information is disclosed in the offering. According to the North American Securities Administrators Association (NASAA) officials, most states additionally conduct a merit reviewan analysis of the fairness of the offering to investorsalthough some states use stricter standards in their merit reviews than others. NASAA officials have encouraged states to take steps to streamline their requirements and make them more uniform, including adopting a standard form for registering securities. NASAA plans to work with states to determine what changes in their registration methods will be needed in light of the Jumpstart Our Business Startups Act (JOBS Act).
Multiple factors appear to have influenced the use of Regulation A and views vary on whether raising the offering threshold will increase its use. The factors included the type of investors businesses sought to attract, the process of filing the offering with SEC, state securities laws, and the cost-effectiveness of Regulation A relative to other SEC exemptions. For example, identifying and addressing individual states securities registration requirements can be both costly and time-consuming for small businesses, according to research, an organization that advocates for small businesses, and securities attorneys that GAO interviewed. Additionally, another SEC exemption is viewed by securities attorneys that GAO met with as more cost-effective for small businesses. For example, through certain Regulation D filings small businesses can raise equity capital without registering securities in individual states, as long as other requirements are met. State securities administrators, a small business advocate, and securities attorneys with whom GAO met had mixed views on whether the higher maximum offering amount ($50 million) under the JOBS Act would lead to increased use of Regulation A. For example, some thought that the higher threshold could encourage greater use of Regulation A, while others told us that many of the factors that have deterred its use in the past likely will continue to make other options more attractive.

section_title: Letter
paragraphs: Small businesses rely on capital to start and expand their businesses.  Some small businesses often satisfy capital needs by asking friends and  family members, or by seeking bank loans. Small businesses that exceed  these resources, or have additional capital needs, may seek to sell  shares of ownership or securities convertible into shares of ownership, in  the business to raise needed cash to be used in operations. One of the  major sources of equity capital is the public offering of securities.
The Securities Act of 1933 (Securities Act) requires companies that are  publicly offering securities for investment to register the offering of the  securities with the Securities and Exchange Commission (SEC) and  provide investors with all material information necessary to make an  investment decision. The Securities Act contains some exemptions from  registration and authorizes SEC to provide by rule for additional  exemptions. In particular, SEC Regulation A exempts from registration  securities offerings if the total offering price does not exceed $5 million  and if certain other requirements are met. SEC has stated that  Regulation A is an effective tool for developing companies that may not  be able to raise sufficient funds to justify the significant costs of  registration.review process for registered offerings, these offerings must go through a  federal filing and review process.
Although Regulation A offerings are not subject to the SEC  In addition, Regulation A offerings are generally subject to registration  requirements under state securities laws, known as blue sky laws. Unless federal law specifically preempts a securities offering from state  regulation, issuers must meet the specific regulatory requirements for  each state in which they want to make an offering.
In an effort to increase small business public offerings, the Jumpstart Our  Business Startups Act (JOBS Act) requires SEC to amend Regulation A  (or to adopt a new regulation) to raise the ceiling for use of that  registration exemption from $5 million to $50 million, among other things.However, questions remain about whether state blue sky laws could  serve as an impediment to greater use of Regulation A. Section 402 of  the JOBS Act requires us to review the impact of state blue sky laws on  Regulation A offerings. This report examines (1) trends in Regulation A  filings, (2) how states register Regulation A filings, and (3) what factors  have affected the number of Regulation A filings and how the number of  filings may change in the future.
The origin of the term “blue sky laws” is subject to a number of different theories. The  most widely held theory attributes it to Justice McKenna’s description of a state securities  law in Hall v. Geiger-Jones Co., 242 U.S. 539, 550 (1917): “The name that is given to the  law indicates the evil at which it is aimed; that is . . . speculative schemes which have no  more basis than so many feet of blue sky . . .” However, a newspaper article written by the  author of the original Kansas law states that the term actually refers to a fraudulent  rainmaking scheme in which the investment promoter “promises rain but delivers blue  sky.” See Rick Fleming, “100 Years of Securities Law: Examining a Foundation Laid in the  Kansas Blue Sky,” 50, no. 3 Washburn Law Journal (Spring 2011). exemptions for certain securities offerings) and registered offerings of up  to $5 million from 2008 through 2011 to illustrate differences in  businesses’ use of other securities offering options. We assessed the  reliability of SEC’s data on Regulation A, Regulation D, and registered  offerings by interviewing agency officials and reviewing documentation  related to SEC’s Electronic Data Gathering, Analysis, and Retrieval  system. We determined the data reliable for our purposes. We also  reviewed SEC’s policies and procedures for qualifying small businesses’  filings for exemption through Regulation A.
To describe how states register Regulation A filings, we reviewed  published research and North American Securities Administrators  Association (NASAA) documentation of state registration methods. We  interviewed NASAA officials to discuss states’ registration methods and  Regulation A filings, and state securities administrators from seven states  to discuss their registration methods. We interviewed a non probability  sample of state administrators’ offices based on geographic diversity,  recent experience with Regulation A, and referrals from NASAA.  Specifically, we interviewed staff from the state securities administrators  of the following: Arkansas, Delaware, Florida, Ohio, Texas, Virginia, and  Washington. We also interviewed a non probability sample of three small  businesses from different industries that had issued Regulation A  offerings in multiple states from 2010 through May 2012 to provide a  diversity of perspectives.
To identify factors that may have affected the number of Regulation A  filings and how the number of filings may change in the future, we  reviewed published research and reports on blue sky laws, Regulation A  and Regulation D usage over time, and small businesses’ access to  equity capital. We also reviewed the JOBS Act, the Securities Exchange  Act of 1934, the Securities Act, and Regulations A and D. In addition, we  interviewed SEC officials and state securities administrators and  representatives from the states and small businesses mentioned above.  We also interviewed attorneys who have assisted small businesses with  obtaining Regulation A exemptions, academics, and organizations that  advocate on behalf of small businesses. We identified and judgmentally  selected these attorneys, academics, and organizations based on  referrals from the American Bar Association and NASAA, testimonies  before Congress, and evidence of having a view on blue sky laws. Based  on these interviews, we identified the most frequently identified factors  affecting the use of Regulation A.
We conducted this performance audit from April to July 2012 in  accordance with generally accepted government auditing standards.  These standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: Businesses can raise capital in the regulated securities markets through  the public offering of securities, which is an offering of stock to the  general public. For a small business, this could take the form of a  registered public offering—an offering and sale of securities to the  general public. Unless subject to a specific exemption, the Securities Act  requires a business selling its securities to file a registration statement  with SEC that includes a prospectus that discloses, among other things,  the business’s operations, financial condition, security offering, risk  factors, and management. Businesses that qualify as smaller reporting  companies under SEC rules can file using disclosure requirements scaled  for small businesses. The Securities Act requires that information  provided to investors in connection with the offer or sale of the business’s  securities include material information necessary to make an investment  decision.
SEC’s Division of Corporation Finance (Corporation Finance) reviews  registration statements for compliance with disclosure and accounting  requirements. Corporation Finance does not evaluate the accuracy of  disclosure, the merits of any transaction, or determine whether an  investment is appropriate for any investor. According to SEC, this review  process is not a guarantee that the disclosure is complete and accurate— responsibility for complete and accurate disclosure lies with the business  and others involved in the preparation of a business’s filings. Through the  course of its review, Corporation Finance may issue comments to a  company to elicit compliance with applicable disclosure requirements. In  response to those comments, a business may revise its financial  statements or amend its disclosure to provide additional information.  According to SEC, this comment process is designed to provide investors  with better disclosure necessary to make informed investment decisions,  thus enhancing investor protection, facilitating capital formation, and  enhancing the efficiency of the capital markets. When a business has  resolved all comments from Corporation Finance on a Securities Act  registration statement, the business may request that SEC declare the  registration statement effective so that it can proceed with the transaction.  A business cannot sell its securities until SEC declares the registration  statement effective.
subsections: section_title: SEC Forum on Small Business Capital Formation
paragraphs: The Small Business Investment Incentive Act of 1980 requires SEC to  conduct an annual forum on small business capital formation. In 2011,  SEC held its 30th forum. According to the resulting report on the forum, a  major purpose of the forum is to provide a platform to highlight perceived  unnecessary impediments to small business capital formation and  address whether they can be eliminated or reduced.to develop recommendations for government and private action to  improve the environment for small business capital formation, consistent  with other public policy goals, including investor protection. The report  made a number of recommendations, including a few related to  Regulation A, such as raising the ceiling to $50 million and preempting  Regulation A offerings from state blue sky law registration requirements.
section_title: Offerings under Regulation A
paragraphs: Regulation A represents an exercise by SEC of its authority under section  3(b) of the Securities Act to exempt offerings of securities from  registration if it finds that registration “is not necessary in the public  interest and for the protection of investors by reason of the small amount  involved or the limited character of the public offering….” SEC has  previously stated that the primary purpose in adopting Regulation A was  to provide a simple and relatively inexpensive procedure for small  business use in raising limited amounts of needed capital. A business  that relies on Regulation A must (1) file for SEC staff review an offering  statement that includes an offering circular and financial statements, and  (2) provide the offering circular to investors. The offering statement also  includes a notification and exhibits. The offering circular is expected to  include, among other things, information on the company; officers,  directors and key personnel; risk factors; use of proceeds; and plan for  distributing the securities.
SEC staff review the initial offering statement (for example, to determine if  it complies with disclosure requirements) and determines if the offering is  qualified (i.e., cleared by SEC). We discuss the review process in more  detail later in this report. Like securities sold in registered offerings,  Regulation A securities can be offered publicly and are freely tradable in  the secondary market. In addition, Regulation A securities can be sold to  both accredited and nonaccredited investors. Accredited investors  include, among others, individuals whose net worth is more than $1  million (not including the value of their primary residence) or whose  individual income exceeds at least $200,000 for the most recent 2 years  and certain institutional investors, such as insurance companies, banks,  and corporations with assets exceeding $5 million. Conversely,  nonaccredited investors include any investor that does not meet the  definition for an accredited investor.
Although Regulation A offerings are generally subject to state blue sky  laws, state exemptions for certain offerings might apply to a Regulation A  issuer. The Uniform Securities Acts of 1956 and 2002, which form the  basis for many blue sky laws, provide a series of exemptions from state- level registration for certain types of securities or transactions. For example, one exemption applies to sales to institutional investors,  federally covered investment advisors, and other purchasers exempted  by a state rule. Furthermore, the JOBS Act preempts state registration  requirements for offerings under the new version of Regulation A if the  securities are sold on a national securities exchange or to “qualified  purchasers” as defined by SEC.
section_title: Offerings under Regulation D
paragraphs: Regulation D is designed to (1) eliminate any unnecessary restrictions  that SEC rules place on small business issuers and (2) achieve uniformity  between state and federal exemptions to facilitate capital formation  consistent with protecting investors. Regulation D contains three  separate but interrelated exemptive rules—Rules 504, 505, and 506—that  allow some businesses to offer and sell their securities without having to  register the securities with SEC.exemptions differ in relation to the size of the offerings to which they  apply or the number and type of investors to which offerings may be  made.
As the following illustrates, the
Rule 504 has a maximum offering amount of $1 million in any 12- month period and generally does not limit the number or type of  investors.
Rule 505 has a maximum offering amount of $5 million in any 12- month period, and the sales are limited to 35 nonaccredited investors  and an unlimited number of accredited investors.
Rule 506 has no dollar limitation and offerings can be sold to up to 35  nonaccredited, sophisticated investors and an unlimited number of  accredited investors.
While businesses do not have to register Regulation D offerings with  SEC, they must notify SEC of initial sales in the offering. SEC does not  comment on or approve these notifications. Businesses that make  offerings under Rules 504 or 505 must register them at the state level if  required in the state in which they are made, while offerings made under  Rule 506 are preempted from state registration by the National Securities  Markets Improvement Act of 1996.
section_title: Blue Sky Laws
paragraphs: In addition to federal securities laws, state securities laws are designed to  protect investors against fraudulent sales practices and activities. While  these laws can vary from state to state, they require securities issuers  (including businesses making small offerings) to register their offerings  with the state before the offerings can be sold in that state unless state  registration for the offering has been preempted by federal law or a state  registration exemption applies. According to state securities  administrators with whom we met, blue sky laws are beneficial because  they provide an additional layer of protection for potential investors.  Moreover, for states that have the statutory authority to assess the merit  of an offering, the state can assess the extent to which the offering is fair  to potential investors, and require the business to address the state’s  concerns before the offering is registered.
section_title: Regulation A Use Has Decreased Since 1997
subsections: section_title: Trends in Regulation A Offerings
paragraphs: The number of Regulation A offerings filed and qualified has declined  significantly after peaking in fiscal years 1997 and 1998 respectively (see  fig. 1). The number of initial Regulation A offerings filed increased from  15 to 116 from 1992 through 1997. Similarly, the number of Regulation A  offerings qualified increased from 14 to 56 during this same time. These  increases followed SEC’s adoption of rules that raised the ceiling for  Regulation A offerings from $1.5 to $5 million as well as allowing  Regulation A offerors to “test the waters” by soliciting investor interest in  the security before incurring preparation costs for the offering statement.  However, since 1997, the number of initial Regulation A offerings filed  decreased significantly—from 116 in 1997 to 19 in 2011. The number of  qualified offerings also dropped dramatically after 1998, decreasing from  57 in 1998 to 1 in 2011. SEC has not evaluated the causes of changes in  the use of Regulation A. Securities attorneys with whom we met stated  that the decrease in filings after 1997 could be attributed to a number of  different factors, including the increased attractiveness of Regulation D.  The National Securities Markets Improvement Act of 1996 preempted  state registration requirements for certain other categories of securities  offerings (including Rule 506 of Regulation D)—potentially making these  other options more attractive to businesses.
Initial qualified Regulation A offerings have varied in size and purpose  and represented a wide range of business lines. Specifically, from 2002  through 2011, the maximum offering amounts for the 82 qualified  Regulation A offerings ranged from $100,000 to $5 million. Over one-third  of these offerings were for $5 million. According to SEC data, the  businesses intended to use the proceeds for purpose such as  capitalization, debt repayment, research and development, and marketing  and advertising. During this period, different types of businesses filed  offerings that qualified for exemption under Regulation A—for example, a  software database service company, industrial design company, senior  assisted living facility, and financial services company. These businesses  were either corporations or limited liability corporations that were located  throughout the United States. In addition, about 24 percent of the  qualified Regulation A offerings were associated with start-up businesses.
Businesses have used Regulation D exemptions and registered initial  public offerings to a greater extent than Regulation A in recent years. We  summarize the trends for these types of offerings and provide comparison  with Regulation A qualified filings in table 1.
Regulation D: According to SEC data, there were over 15,500 initial  Regulation D filings for up to $5 million in fiscal years 2010 and 2011.  In comparison, there were 8 qualified initial Regulation A offerings  during this period. According to a recent report prepared for SEC, the  median Regulation D offering was $1 million from January 2009  through March 2011 and the overwhelming majority of Regulation D  issuers have been issuing securities under Rule 506.
Registered Public Offerings: Businesses may decide to sell their  securities through a registered public offering rather than seeking a  Regulation A or another type of exemption—meaning that they must  complete the registration process under the Securities Act. Data show  that businesses more frequently opted to conduct a registered public  offering than seek a Regulation A exemption. From fiscal years 2008  through 2011, the number of initial registered public offerings ranged  from 536 to 195 each year, while the number of qualified initial  Regulation A offerings statements ranged from 1 to 8. SEC staff said  that some businesses may switch to a registered public offering  instead of completing the Regulation A filing process.
SEC’s process for reviewing filings for exemption through Regulation A  includes multiple steps. First, Corporation Finance staff review the  offering statement, which includes financial statements that have been  prepared according to generally accepted accounting principles. More  specifically, staff review filings to determine whether disclosures appear  to be consistent with SEC rules and applicable accounting standards.  Staff can then comment on the offering statement. That is, they may note  deficiencies with the offering documents or ask for clarifications.  According to SEC staff, deficiencies could include inadequate disclosure  or incomplete financial statements. The goal of SEC staff is to provide  comments on Regulation A filings within 27 calendar days of the filing  date. Businesses are then given the opportunity to provide written  responses and, if appropriate, amend their filing based on SEC’s  comments. Depending on the nature of the issue, SEC’s concern, and the  response from the business, agency staff may issue additional comments  following their review of the response. This comment and response  process continues until all SEC comments are resolved, at which time  SEC qualifies the filing.
The time period for SEC to complete its review process can be lengthy  depending on the quality and completeness of the offering statement, the  extent of SEC’s comments on the offering statement, and the business’s  response. According to SEC data, from 2002 through 2011 it took an  average of 228 days for 82 offering statements to complete the review  process, starting from the date the Regulation A exemption was filed  through the date SEC qualified the filing. SEC staff told us that the length  of the review process depends largely on the quality of the filing initially  and how quickly and thoroughly the business responds to their  comments. Because of the amount of time it can take to complete SEC’s  review process, an issuer whom we interviewed said that they  concurrently filed their Regulation A offerings with SEC and the  appropriate state(s).
A business can opt not to continue seeking exemption through Regulation  A at any point during SEC’s review process. SEC may declare an offering  statement to be “abandoned” when the business fails to amend the  offering statement for a lengthy time period and fails to respond to an  abandonment notice. A filing may be “withdrawn” if the business informs  SEC that it no longer wants to proceed and requests the offering  statement be withdrawn and the SEC consents to the withdrawal.  Between 1992 and May 2012, 214 of the 1,006 Regulation A filings made  with SEC were abandoned or withdrawn. As discussed earlier, SEC  staff stated that they have received anecdotal information that some  businesses abandon or withdraw from the Regulation A filing process to  raise capital through different means, such as the issuance of registered  public offering.
section_title: States’ Methods of Registering Regulation A Securities Offerings Vary
paragraphs: Although states employ a limited number of methods for registering  securities offerings, specific requirements and processes vary. States  generally use one of two methods for registering Regulation A  securities—registration by qualification or registration by coordination.
Registration by qualification is similar to a securities registration with  SEC under the Securities Act. Specifically, the issuer submits required  documents to the state securities agency, and the offering is subject  to approval by that agency under the state’s standards.
Registration by coordination is available to issuers that have  registered their offerings with SEC.copies of their SEC registration statement and any amendments with  the state agency for review. A registration by coordination usually  becomes effective at the state level at the time it becomes effective at  the federal level. Although the content of the filing and the procedure  by which it becomes effective is streamlined in this process, it is still  subject to state administrator review.
Under this method, issuers file  While all states conduct disclosure reviews of Regulation A securities  offerings, most states also conduct merit reviews. Disclosure reviews  follow the federal approach, requiring only full disclosure of all material  information in offering statements. A merit review is an analysis of the  offering using substantive standards (for example, the disparity in the  price paid by promoters for their shares and the price paid by public  investors). If an offering is considered unfair in certain respects, a state  securities administrator will issue comments on the substance of the  offering, and, as in SEC’s review process, the business has an  opportunity to respond to the state’s comments. According to NASAA, if  the business does not adequately address the state’s concerns, the state  securities administrator may refuse to declare the registration statement  effective in that state.
Merit reviews have varying degrees of stringency, with some states  applying stricter standards than others. For example, according to one of  the state securities administrators with whom we met, the state’s blue sky  laws require businesses that seek to offer securities to have a consistent  record of earnings for the preceding 3 fiscal years. Other states may not  have the same requirements for records of earnings. According to a state  securities administrator official from a merit state, that state may require  proceeds from investors to be placed in escrow until a certain level of  proceeds is reached.  For example, where an offering provides that a  certain level of securities must be sold before proceeds are released to  an issuer, the state requires the issuer to place all proceeds from  investors in that state in an escrow account with a depository in that state  until the level is reached. The funds cannot be released without  authorization from the state agency. Although state registration processes  can improve investor confidence, they can be costly and time-consuming  for businesses seeking to raise capital according to issuers and securities  attorneys with whom we met.
Recognizing these potential costs, NASAA has developed and  encouraged states’ use of methods to make registration of securities,  including Regulation A offerings, more streamlined for multistate  offerings. For example, 44 states allow businesses to use a standard form  (called the SCOR form) to register their security offering. The SCOR form  was adopted by NASAA in 1996 and is designed to simplify and reduce  the costs to businesses of registering their securities. SCOR offers a  simplified question-and-answer registration format and becomes the main  disclosure document for securities offerings at the state level. Businesses  that are exempt from federal registration under Regulation A can use the  SCOR form in those states that accept it.
As another means of streamlining the state registration process, some  states participate in coordinated review programs—also known as  regional reviews. A regional review expedites multistate registration,  thereby potentially saving issuers time and money. Regional reviews are  available in the New England, Mid-Atlantic, Midwest, Southwestern,  Southeastern, and Western regions. Each state participating in the  program agrees to apply uniform standards regarding such matters as the  time frame for issuing comments and the type of comments to be issued  in reviewing registration applications. According to NASAA, approximately  37 states participate in regional reviews.
The efficacy of the efforts to streamline the state registration process is  unknown. According to several of the state securities administrators  whom we interviewed, they have not participated in regional reviews or  used SCOR forms for Regulation A filings because there have been so  few Regulation A filings in their state. Similarly, a researcher and  securities attorneys with whom we met noted that some of these  methods, like SCOR, have not been widely used because of the low  number of Regulation A filings in recent years.
According to officials from NASAA, changes to the states’ registration  processes and requirements are likely needed to coincide with the new  exemption for larger offerings under the JOBS Act. NASAA staff stated  that they recognize that issuers may want to conduct nationwide offerings  under the larger federal exemption, which increases the need for uniform  state-level registration requirements for such larger offerings. In  particular, the increased ceiling amount could encourage smaller  community banks as well as those businesses that do not want to limit  themselves to accredited investors or investors in a single state to pursue  a Regulation A filing. Officials from organizations that work to develop  capital intensive businesses agreed that in order for small businesses to  use the Regulation A exemption, the process to register in multiple states  needed to be more streamlined and entail minimal cost and greater  efficiency. NASAA plans to work with the states to promote a more  uniform state-level registration process for larger offerings. In addition,  NASAA plans to coordinate with SEC on new disclosure forms for larger  offerings—with the goal of developing a disclosure form that can be used  at the federal and state level. According to NASAA officials, the time  frame for making these and other changes is unknown, as the states  must wait for SEC to issue certain rules under the JOBS Act.
section_title: Multiple Factors May Have Affected Use of Regulation A and Views on Future Use Are Mixed
paragraphs: According to the stakeholders with whom we met, multiple factors may  have influenced small businesses’ decision to use Regulation A. These  factors included the type of investors businesses sought to attract, the  process of filing the offering with SEC, state securities laws, and the cost- effectiveness of Regulation A relative to other SEC exemptions. Views  vary on whether use of Regulation A will increase, with some  stakeholders stating that interest will increase as a result of the $50  million ceiling, and others stating that the requirement for issuers to  register the securities at the state level will continue to deter small  businesses from using the exemption.
subsections: section_title: Factors That May Have Affected Regulation A Use
paragraphs: Multiple factors appear to have influenced whether small businesses used  Regulation A to raise equity capital, according to recent issuers and other  stakeholders with whom we met. Regulation A has been attractive to  small businesses because, among other things, they can sell the  securities to nonaccredited investors. However, other factors, including  SEC’s process for qualifying Regulation A filings, the requirement for  Regulation A issuers to comply with blue sky laws, and the benefits  associated with Regulation D have played a role in limiting the use of  Regulation A to date.
Small businesses that wanted nonaccredited investors to purchase their  securities have opted to use Regulation A, according to recent issuers of  Regulation A securities as well as other stakeholders with whom we met.  One issuer stated that working with investors that supported its social  mission was important, and that these investors were not necessarily  accredited. Another issuer stated that the business wanted to sell its  securities to specific investors with whom it had existing relationships— which also were not necessarily accredited. In both cases, the issuers  explained that had they used a different SEC exemption to raise capital,  such as Regulation D, they would not have been able to sell their  securities to their desired investors. Representatives of one issuer also  noted that they wanted to offer their securities to the public, and  Regulation A enabled them to do so.  This company offered its securities  on the internet.  Securities attorneys who have experience in assisting  small businesses raise equity capital similarly stated that Regulation A  has been attractive to businesses that desired to make their securities  available to members of the businesses’ local community.
The process of filing a Regulation A offering with SEC, and working with  SEC to qualify the filing, can be time-consuming and costly, according to  several stakeholders with whom we met. For example, several  stakeholders, (including a recent Regulation A issuer, attorneys who  worked with recent issuers, and a small business advocate) described the  process as detailed and time consuming; two of these stakeholders  described the process as akin to filing a registered public offering. Other  stakeholders noted that the process of filing a Regulation A offering is  considered in the industry to be a “mini-registration.” Stakeholders also  noted that because the process of receiving and addressing comments  from SEC could entail multiple rounds that involved attorneys and  accountants, it could be costly to the small businesses involved. Two of  the Regulation A issuers with whom we met stated that SEC required  them to address comments related to their financial statements, and that  such comments required the issuers to work with their accountants to  clarify accounting-related information, which was costly. According to  SEC, its process of qualifying Regulation A offerings is designed to  protect investors. SEC staff stated that in some cases the businesses that  were seeking exemption through Regulation A did not fully address SEC’s  comments and requests for clarification, which resulted in additional  comment letters as well as informal communication.
Identifying and addressing the securities registration requirements of  individual states is both costly and time-consuming for small businesses,  according to research, an advocate for small businesses, and securities  attorneys with whom we met. For example, one academic who has  researched and written extensively about blue sky laws believes that they  impose significant costs on small businesses and impair capital  formation. According to this researcher, the costs to issuers of  addressing blue sky laws have been a significant factor in the historic  underuse of Regulation A by small businesses. An advocate for small  businesses as well as securities attorneys with whom we met agreed with  this assessment. An organization that advocates for small businesses  noted that small businesses have limited resources; thus, the legal  expenses associated with researching and complying with state securities  laws can be a significant burden. Securities attorneys who have  experience in assisting small businesses with obtaining the Regulation A  exemption noted that their legal fees were relatively high due to the need  to research individual state’s blue sky laws. For example, one attorney  who works with start-up technology firms stated that his fees associated  with Regulation A were high because of the need to research state laws,  prepare offering documents for individual states, and address comments  both from SEC and some states.
Some states’ securities registration requirements deterred small  businesses from registering in those states. For example, a  representative of one of the Regulation A issuers with whom we met  stated that the issuer was deterred from registering in a specific state  because of the state’s requirement for issuers to have a consistent record  of earnings for the preceding three fiscal years. He stated that because  the business was relatively new and had not yet become profitable— particularly during the recent financial crisis—it could not meet this  requirement. According to the securities administrator for this state, the  state’s securities laws are intended to help ensure fair, just, and equitable  offerings for investors, but other means exist to meet the state’s  requirements. As another example, one issuer opted to withdraw its  application from a state that provided extensive comments on the  business’s offering. According to an official from this state’s securities  administrator, small businesses withdraw from the process of registering  with the state, likely to avoid having to address the state’s comments.
Merit review states are viewed by some stakeholders as presenting  greater challenges for small businesses that want to register Regulation A  securities. As previously discussed, states assess the fairness of  offerings in merit reviews and require businesses to address their  comments before securities can be registered. For example, we met with  securities attorneys who had experience obtaining Regulation A  exemptions for small businesses. Some of the attorneys stated that they  advised their clients to avoid registering in merit states. The legal counsel  for one recent Regulation A issuer noted that after researching merit  review states and contacting the securities administrator for one of these  states, it became evident that the review processes in such states would  be time-consuming and burdensome to address. The counsel advised,  and the issuer agreed, to avoid attempting to register in any merit states.  As noted earlier, according to NASAA officials, most states perform merit  reviews. Issuers with whom we met stated that they registered in 3 to 11  states.
Another SEC exemption—Rule 506 of Regulation D—historically has  been preferable to Regulation A because of its time and cost benefits and  lack of offering ceiling, according to an organization that advocates on  behalf of small businesses and securities attorneys with experience in  working with small businesses to raise equity capital. For example, one  small business advocate stated that a small business has little reason to  use Regulation A, particularly if it can use Rule 506 of Regulation D,  which preempts blue sky laws. That is, a business that uses Rule 506 of  Regulation D can raise equity capital without having to register the  security in individual states, saving the business both time and money.  Securities attorneys with whom we met agreed that Rule 506 of  Regulation D is a preferable method of raising capital for small  businesses because it is more cost-effective. As an example, one  attorney noted that technology firms have been more inclined to use Rule  506 of Regulation D over Regulation A because the legal costs were  lower, and such offerings could be made more quickly. For the technology  industry, there are risks associated with time; thus, these firms want to  obtain capital quickly. SEC staff stated that for Regulation D, businesses  are required to notify SEC of the offerings, and that SEC does not  generally provide comments on the notifications. Securities attorneys,  staff from the offices of some state securities administrators, and other  stakeholders with whom we met noted that Regulation D in general is  preferable to Regulation A because the process of filing the required  information with SEC is quicker and less burdensome.
According to stakeholders whom we interviewed, Rule 506 of Regulation  D also has been viewed as preferable to Regulation A because it did not  have a maximum offer ceiling. Staff from some of the state securities  administrator’s offices with whom we met stated that use of Regulation  A’s had been low because the maximum offering amount was too small,  and Regulation A was not as cost-effective as other financing  mechanisms. Some securities attorneys with whom we met similarly  described the Regulation A ceiling as too low, and stated that Rule 506 of  Regulation D was very attractive in comparison. Securities attorneys also  noted that the legal costs associated with Regulation A offerings were  greater than those associated with Regulation D offerings. In addition, we  previously reported that one of the reasons given for the limited use of  Regulation A was that it was rare for an issuer to attract an underwriter for  an offering under $5 million.securities attorneys with whom we met agreed that offerings of $5 million  or less were viewed unfavorably by underwriters because they were too  small in size to be profitable.
section_title: Views on Future Growth of Regulation A Filings Were Mixed
paragraphs: The number of small business that seek exemption through Regulation A  may increase as a result of the JOBS Act’s requirement for SEC to  increase the maximum offering amount to $50 million, according to staff  from some state securities administrators’ offices, a small business  advocate, and securities attorneys whom we interviewed. A small  business advocate with whom we met stated the higher ceiling increase  could attract those businesses for which the $5 million ceiling was too  low. Moreover, this advocate noted that some small businesses may want  to enter the securities market but are not yet prepared to register an  offering with SEC; thus, Regulation A would be a good way for them to  enter the market. The higher ceiling also could increase underwriters’  interest in Regulation A, according to some stakeholders we interviewed.  While investment banks are not interested in $5 million offerings, they are  more likely to be interested in offerings that are closer to $50 million,  according to some stakeholders.
Under the JOBS Act, future Regulation A offerings generally remain  subject to state blue sky laws, which may deter future use by small  businesses. As previously discussed, addressing and complying with  securities registration requirements of states can be costly and time- consuming, according to several stakeholders with whom we met. Recent  Regulation A issuers, a small businesses advocate, and securities  attorneys we interviewed stated that researching individual state laws and  registering with multiple states significantly increased the legal and  accounting costs associated with Regulation A offerings. As a result, even  with the increased attractiveness of the $50 million ceiling, blue sky  requirements may still dampen small business’ interest in Regulation A.  However, some stakeholders also noted that with the increased ceiling, a  Regulation A offering’s transaction costs (attorney fees and accounting  costs) will represent a smaller proportion of the overall offering costs.
In addition, Rule 506 of Regulation D may continue to be preferable to  Regulation A, according to securities attorneys, staff from some of the  state securities administrator’s offices, and another stakeholder whom we  interviewed. Most notably, businesses that use Rule 506 of Regulation D  do not to have to have the offering qualified by SEC or register in  individual states, and can raise unlimited amounts of capital. Furthermore,  the JOBS Act contains provisions that will allow issuers to make general  solicitations and advertise offerings made under Rule 506 exclusively to  accredited investors, which may further add to the appeal of Regulation D  offerings.
section_title: Agency Comments
paragraphs: We provided a draft of this report to SEC and NASAA for their review and  comment. Both provided technical comments, which we incorporated as  appropriate.  NASAA also provided written comments, which are reprinted  in appendix I.  In its letter, NASAA concurred with our finding that multiple  factors have affected use of Regulation A, and suggested that the primary  reason for its limited use is the “mini-public offering” process that  businesses must complete.  Stakeholders with whom we met did not  consistently cite any single factor as the primary reason for the limited  use of Regulation A.  As noted in the report, NASAA stated that it will be  working to develop model state registration requirements for the larger  Regulation A offerings allowed under the JOBS Act, and NASAA  suggested that further changes to federal securities laws, particularly  Regulation A, should be withheld until states implement a new system to  address the JOBS Act's changes.  In considering any changes, NASAA  stressed the importance of balancing the needs of investors with the  needs of businesses seeking to raise capital.
We are sending copies of this report to the Chairman of the Securities  and Exchange Commission, the appropriate congressional committees,  and other interested parties. In addition, the report will be available at no  charge on GAO’s website at http://www.gao.gov.
If you or your staffs have any questions about this report, please contact  me at (202) 512-8678 or clowersa@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made major contributions to  this report are listed in appendix II.
section_title: Appendix I: Comments from the North American Securities Administrators Association
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the individual named above Andrew Pauline, Assistant  Director, Elizabeth Jimenez, Wati Kadzai, Marc Molino, Lisa Moore,  Barbara Roesmann, and Henry Wray made major contributions to this  report.