The Common Mistakes of Regulation D Offerings
Regulation D issuers may face many challenges when filing their offering. Avoid these common mistakes to ensure your private offering’s compliance.
Introduction to Regulation A Offerings
Regulation A, often referred to as “Reg A,” provides an exemption from the registration requirements pursuant to the Securities Act of 1933 for issuers seeking to sell securities to the public. Opting for a Reg A offering allows an issuer to raise funds from the public without incurring the heightened expense and liability associated with the registration process of a full-blown public offering. In 2015, the Securities and Exchange Commission (SEC) introduced final rules to establish two tiers under Reg A—Tier 1 and Tier 2. While both tiers share some similarities, variations exist in their reporting obligations and offering limits.
Reg A Tier Comparison: Tier 1 vs Tier 2
Both Tier 1 and Tier 2 offerings require the submission of an offering statement, consisting of Form 1-A and supplemental information, to the Securities and Exchange Commission (SEC). Following the submission, Tier 1 and Tier 2 issuers must await qualification by the SEC before commencing sales in the offering.
Under Tier 1, issuers can raise a maximum of $20 million in a twelve-month period without the requirement for ongoing reporting from non-accredited and accredited investors. Issuers do not have ongoing reporting requirements but must submit a report on the final status of the offering to the SEC. Testing the waters is permissible either before or after filing the offering statement subject to state securities laws. One advantage of a Tier 1 offering over a Tier 2 offering is that Tier 1 financials do not need to be audited.
Securities sold under a Tier 1 offering are not considered Covered Securities, which means that issuers must still comply with each state securities commission by registering or qualifying the offering prior to selling. This process requires coordinated review and approval from each state.
Under Tier 2, issuers can raise a maximum of $75 million within a twelve-month period from non-accredited and accredited investors, but they are obligated to meet periodic reporting requirements. These include submitting annual reports, semi-annual reports, amendments to address changes in circumstances, and a report on the final status of the offering. Testing the waters is permissible either before or after filing the offering statement subject to state securities laws.
Securities sold under a Tier 2 offering are considered Covered Securities. As such, Tier 2 offerings are preempted from state review and qualification.
Despite the increased reporting requirements associated with a Tier 2 offering compared to a Tier 1 offering, Tier 2 accounted for 70% of Regulation A offerings from 2015 to 2019.
Regulation A, Tier 2 Issuer Eligibility
Any company formed in the United States or Canada is eligible to seek exemption under Regulation A, Tier 2, with the additional requirement that its principal place of business must be in the US or Canada.
Additional scenarios that would disqualify an issuer include:
- Investment companies required to register under the Investment Company Act of 1940, or a business development company defined in Section 2(a)(48).
- A blank check company
- An issuer disqualified under SEC “bad actor” qualification rules
Limitations exist on what kinds of securities can be offered under Reg A. For example, an issuer cannot issue fractional undivided interests in oil or gas rights, or similar interest in other mineral rights. They also cannot issue asset-backed securities as defined in Item 1101(c) of Regulation AB.
Regulation A, Tier 2 Federal Compliance Requirements
Form 1-A
Issuers undertaking a Regulation A offering are obligated to submit Form 1-A to the SEC, consisting of three parts: Part I (Notification), Part II (Information Required in an Offering Circular), and Part III (Exhibits).
Part I consists of general information about the issuer, the issuer’s eligibility, and general information about the offering, such as the type of securities being offered and the anticipated fees associated with the offering.
Part II outlines the information required in the offering circular. The offering circular is where the issuer furnishes comprehensive information about their offering for potential investors, including general information about the issuer and the offering, as well as risk factors for the investment, dilution, plan of distribution, financial information, management, and more. The structure of the offering circular is regulated to promote consistency and honesty. Once approved by the SEC, the offering circular must be provided to all potential investors participating in the Regulation A, Tier 2 offering.
Part III contains exhibits to provide further context or evidence to support the information shared in prior parts of Form 1-A. For example, an issuer should attach any voting agreements that impact the rights of the securities holders as an exhibit.
Form 1-A must be completed at least 21 days prior to the SEC’s qualification of the offering statement.
For further information, see the SEC’s guidance for completing Form 1-A.
A 'No Objection Letter'
The sale of Reg A securities cannot commence until the Financial Industry Regulatory Authority (FINRA) provides the issuer with a ‘No Objection Letter’. The ‘No Objection Letter’ indicates that FINRA has completed its review of the offering.
FINRA’s review consists of two rounds which take approximately 10 to 25 business days in total. After the review, FINRA will return one of three letters: a ‘No Objection Letter’, a ‘Defer Letter’, or an ‘Unreasonable Letter’. A ‘No Objection Letter’ signifies that the offering review is complete, and the issuer can proceed based off the information submitted. ‘A Defer Letter’ is granted if FINRA has concerns or questions and needs further documentation. An ‘Unreasonable Letter’ is given if FINRA deems that the terms of the offering do not comply with corporate financing rules.
Qualification
Once initial requirements are fulfilled, the SEC will provide a notice of qualification and the issuer will choose their qualification date. Issuers must wait until the SEC’s approved qualification date to begin official sales of the offering. The qualification date is reported in state securities filings.
Testing the Waters
Although the sale of Reg A securities cannot commence until FINRA provides the issuer with a ‘No Objection Letter’ and the SEC qualifies the offering, there is a process known as “Testing the Waters” in which the issuer can lawfully gauge investor interest prior to qualification. By testing the waters, issuers are permitted to solicit interest in a potential offering from the general public, even before the filing of the offering statement.
Ongoing Compliance
Adherence to federal securities laws extends beyond the initial requirements. Issuers must satisfy ongoing reporting requirements. The following reports are the most common forms of maintaining ongoing compliance. This list is not all-inclusive and issuers should do thorough investigation into additional reporting requirements for their specific circumstances.
1-K Annual Report
Issuers of Reg A, Tier 2 offerings are required to submit electronic annual reports through EDGAR within 120 days of the issuer’s fiscal year end. Through the 1-K, the issuer discloses business operations from the past 3 years (or, if established less for than 3 years, since inception) and provides updates to information submitted in Part I of Form 1-A.
1-SA Semiannual Report
Tier 2 issuers must electronically file Form 1-SA within 90 calendar days of the end of the first 6 months of the issuer’s fiscal year. In this report, the issuer discloses interim financial statements.
1-U Current Report
Reg A, Tier 2 issuers must submit 1-U reports within four business days of significant events.
Significant events include:
- Fundamental changes
- Bankruptcy or receivership
- Material modification to the rights of securityholders
- Changes in the issuer’s certifying accountant
- Non-reliance on previous financial statements or a related audited report or completed interim review
- Departure of the principal executive officer, principal financial officer, or principal accounting officer
- Unregistered sales of 10% or more of outstanding equity securities
1-Z Exit Report
The 1-Z is an exit report that is mandatory for all issuers involved in Tier 1 offerings, and it must be submitted within 30 calendar days following the conclusion of their Regulation A offering. Tier 2 issuers are only required to disclose termination of the offering if it was not disclosed previously in a 1-K annual report.
Regulation A, Tier 2 State Compliance Requirements
Introduction to Blue Sky Compliance
Blue sky laws are state regulations designed to prevent securities fraud. The term originates from the depiction of the unregulated securities industry as speculative, where offerings were deemed to have “no more basis than so many feet of blue sky.” Blue sky laws vary based on the state where the offering is sold.
Under Regulation A, Tier 1, the securities sold are not deemed Covered Securities. As such, issuers must still comply with each state securities regulations by either registering or qualifying the offering prior to selling. This process requires coordinated review and approval from each state.
Under Regulation A, Tier 2, the securities sold are deemed Covered Securities. As such, states are preempted from requiring registration or qualification of offerings. However, states can, and often do, mandate notice filings.
In-Depth Blue Sky Compliance Resource
Understand more about state Blue Sky compliance for Reg A, Tier 2 offerings by downloading our resource, The Path to Blue Sky Compliance.
Understand more about state Blue Sky compliance for Reg A, Tier 2 offerings by downloading our resource, The Path to Blue Sky Compliance.
Reg A, Tier 2 Notice Filings
Submission of notice filings is the most common state compliance requirement for Reg A, Tier 2 offerings. A majority of states require notice filings, with only 12 states not mandating notice. Although the filing itself is similar between the states, variations exist in the timing, filing fee amount, issuer-dealer requirements, and method of filing from state to state.
For example, state filing fees could be a flat fee or variable based on the offering’s sales. The map below demonstrates the wide range in fees between the states, from $0 to $1,000+.
Ongoing Compliance
Adherence to state blue sky laws extends beyond the submission of initial notice filings. States often mandate annual renewal filings. In most states, the renewal is due one year from the date of the initial notice delivery to that state. However, Illinois requires a renewal filing one year from the qualification date. These nuances, while seemingly small, can affect whether an issuer complies with state securities laws.
In addition to meeting annual Reg A, Tier 2 renewal obligations, issuers must monitor their sales in each state to prevent “over selling.” This is crucial in states with variable fees, as these fees are contingent on the sales figures declared in the initial filing. If an issuer surpasses the sales initially reported in a specific state, they are required to amend their filing to reflect the updated projected sales amount.
Take for example Texas, where the filing fee for a state notice is 1/10 of 1% of an offering. When submitting an initial notice filing, an issuer could denote that they anticipate selling up to $75,000,000 in Texas, but that would land them with a $75,000 filing fee. This leads many issuers to try to provide a closer estimate of the amount they anticipate selling in Texas. If the issuer instead denotes that they anticipate selling $2,000,000 in Texas, they will have a $2,000 filing fee. However, if the offering goes well and it looks like there are investments totaling $3,000,000 in Texas, the issuer must amend their initial filing and pay an additional fee to avoid an over sale.
Navigating Compliance
While there is a lot of guidance available through the SEC, the nuances of compliance with federal and state securities laws are difficult for any issuer to navigate. Looking for assistance with launching and managing the compliance of your Regulation A, Tier 2 offering? Don’t hesitate to reach out to our team for assistance.
Issuers of private offerings, such as Regulation D 506(b) or 506(c), can stumble across multiple opportunities to make errors. Avoiding these common mistakes is essential to the compliance of your offering.
Many Reg D Mistakes are Avoidable
Over the course of launching your Regulation D 506(b) and 506(c) offerings, administrative tasks can feel like a distraction and a waste of time. On top of the typical administrative tasks, you must also pay attention to the compliance requirements of your offering. Form ID, Form D, and maybe even a Form DA need to be filed with the SEC and in many states where issuers have sold their offering and want permission to continue to sell. While these forms can be time-consuming to file, strict state rules exist to protect consumers and investors nationwide. To ensure compliance, states often administer fines and other penalties to non-compliant funds. Non-compliance is not only costly, but also affects the reputation of the issuer and their ability to sell securities at all.
It’s crucial to assess your offering correctly and ensure that you’ve taken the necessary steps for compliance. However, you won’t know each and every detail of securities laws in all 50 US states or have the time to research them all – that’s why we’ve collected some of the most common mistakes we see when working with clients on Reg D offerings.
Mistake #1: Filing Form D Incorrectly
Frequently, issues with Reg D filings originate from mistakes in completing Form D itself. For example, there may be simple mistakes like having parts of your address on the wrong lines, incorrect industry classifications, or reporting only entities as related persons. On the other hand, some issues are conceptual misunderstandings that demand technical knowledge of 506(b) and 506(c) reporting requirements and changes to legislation.
Senior securities paralegal Kathy Rasler reports that clients sometimes misinterpret the date of the first sale. She says, “sometimes clients believe that the date of first sale is when funds have been accepted by the issuer, but that’s not always the case.” The date of first sale is deemed to be the date on which the first investor is irrevocably contractually committed to invest. Oftentimes this happens once both parties have signed an agreement, such as a subscription agreement, and funds have been received.
Further mistakes in private offering filings include incorrect numerical records. The ‘Minimum Investment’ field, for example, is a common source of error. Oftentimes issuers assume this figure would only include salaries. On the contrary, this figure should include all amounts paid which would include any incentives, bonuses, or other quantifiable gains.
Filing a Form D correctly requires knowing exactly how different pieces of information should be reported. Agile Legal’s experts stay up to date with regulatory changes to ensure your filings are correct and filed efficiently. Fill out our contact form to engage our team to correctly file your Form D on your behalf.
Mistake #2: Making Regulation D Filings in Unnecessary States
Some outside counsel will recommend filing in states where you’re not required to because it can seem like less of a hassle. According to Reyner Meikle, CEO of Agile Legal, “Counsel will often recommend over-compliance because of the cost of advice rather than reviewing the rules for each state to determine where you need to file.” However, this can lead to paying counsel for filings that you don’t need and associated state filing fees that can be avoided. For example, the De Minimis Rule means that you don’t have to file in a state where you have fewer than five investors in a 12-month period. Without having the proper knowledge about filing exemptions, issuers may end up filing when they only have one investor.
Filing in more states than required can also lead to complications and confusion when managing your offerings down the line. Over-filing leaves you with unnecessary ongoing compliance obligations and regulations to keep track of, as well as potential scrutiny from state regulators whose jurisdiction you don’t actually fall under. We all know that issuers are busy enough without unnecessary work adding to their burden and taking up time that could be spent more productively.
Mistake #3: Improper Research of Regulation D Requirements and Exemptions
Missing a filing or stating the incorrect number of sales can lead to serious consequences such as fines and other penalties, as filing your offerings is often a requirement for sale in many states. In worst-case scenarios, it can even lead to disbarment or recission – having to give the money back. While this is not usually the case, it is a risk that comes with under-filing and not being in compliance with SEC and Blue Sky laws.
This form of non-compliance can come from disorganization and inadequate research into which states need filing. Doing your due diligence and keeping track of the offering’s sales can prevent you from reporting incorrectly. In the case of non-compliance, you need to make, or amend, the required filings as soon as possible to avoid penalties being imposed.
Trusting the Right Provider for Regulation D Compliance Support
Trusting a legal service provider with your private offering’s compliance is a big step. You’ll be depending on your provider to protect your reputation and limit your liability if something were to go wrong. Agile Legal provides a team of experienced and dependable paralegals that have a deep understanding of Regulation D compliance requirements.
Collaborative, dedicated, and thoughtful are our core characteristics. Our fund services team is dedicated to researching and understanding the ever-changing regulations nationwide in order to relay the most accurate information to our clients. We assess and file your Form ID, Form D, and Form DAs with thoughtfulness and a detail-oriented mindset to reduce your risk of having to file unnecessary amendments. We’ll collaborate with you to monitor your offering’s sales and Blue Sky compliance across all US states after filings are complete.
You can feel secure knowing that your Reg D offering is compliant with both state and federal requirements. Contact us today to ensure your fund’s compliance and that you are able to sell your offering without anything standing in your way.