Blue Sky Compliance for Secondary Trading: Proposed Regulation A+ Highlights Ongoing Issue

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Discussions about Regulation A+ and equity crowdfunding are highlighting an ongoing pain issue TSX and TSX Venture Issuers have long faced when dealing with Blue sky compliance for secondary trading in the United States. Blue sky laws refer to individual state securities laws.  In the United States the issuance and trading of securities is governed by federally enacted securities laws and individual state enacted securities laws.  These laws do not always work in harmony. [1]

At the federal level the issuance of securities is governed by the United States Securities and Exchange Act of 1933 (1933 Act) and the subsequent secondary trading of securities by investors is governed by the United States Securities and Exchange Act of 1934 (1934 Act). State securities laws, also known as blue sky laws, also apply to these transactions when a buyer or a seller resides within a particular state.  The only time state securities laws do not apply to a transaction is when they have been pre-empted by federal securities laws.

Preemption of State Securities Laws

The National Securities Markets Improvement Act of 1996 (NSMIA) preempts state law from applying to securities that are:

  • listed or approved for listing on an exchange (NYSE, NYSE-Market, Nasdaq and certain other Securities and Exchange Commission (SEC)-designated exchanges);
  • issued by a listed company and equal or senior in rank to its listed securities (e.g., bonds issued by an issuer with listed stock);
  • sold to “qualified purchasers,” (a term the SEC has yet to define);
  • sold in secondary market transactions (i.e., transactions under Sections 4(1) or 4(3) of the 1933 Act) involving securities of 1934 Act registrants;
  • sold in Regulation D offerings under Rule 506; and
  • exempt from registration by some–but not all–provisions of Section 3(a) of the Securities Act (including Section 3(a)(9) exchanges, government or municipal securities, bank securities and commercial paper, but not including securities issued under Section 3(a)(10) fairness hearings).

State securities regulators can impose a notice filing requirement for securities covered under NSMIA not otherwise listed on an exchange or issued by a listed company described in the first and second bullet points above. The TSX, TSX Venture Exchange, OTC Bulletin Board, and the OTC Markets Group markets are not SEC designated exchanges for the purpose of NSMIA and preemption of state securities laws. State securities laws therefore apply any time an offer of securities is made in a primary offering (private placement and prospectus offerings) or a secondary trade of securities by issuers listed or quoted on these markets.

Proposed Regulation A+

Regulation A and the proposed Regulation A+ rules, exempt limited issuances of securities from the registration and prospectus requirements under the 1933 Act. Securities issued under a Regulation A or a proposed Regulation A+ offering are not “restricted securities” and therefore not subject to a hold period. Regulation A+ is only available to issuers who:

  • are not a reporting issuer under the United States Securities Exchange Act of 1934 (1934 Act);
  • are organized under and have their principal place of business in the United States or Canada;
  • are not an investment company or blank check company;
  • are not issuing fractional undivided interests in oil and gas rights, or a similar interest in mineral rights;
  • do not have its securities suspended or revoked under the 1934 Act;
  • are not disqualified under the “bad actor” disqualification rules; and
  • have filed all required Regulation A+ exempt distribution reports during the past two years.

Regulation A+ creates two tiers of offerings: Tier 1, for offerings of up to $5 million in a twelve-month period (which mirrors the current Regulation A rule), and Tier 2, for offerings of up to $50 million in a twelve-month period. Issuers may offer equity securities, debt securities, and debt securities convertible or exchangeable for equity interests, including any guarantees of such securities under Regulation A+. These securities may be offered to anyone subject to certain investment limits.[2]

Under both tiers issuers must prepare a disclosure document in the required form. These disclosure documents are subject to regulatory review. The SEC is proposing that offerings under Tier 2 of Regulation A+ be exempt from state blue sky laws and review. This preemption is being accomplished by defining “qualified purchasers” under NSMIA to include all purchasers of securities offered under Tier 2 of Regulation A. Tier I Regulation A+ offering will be subject to SEC and state regulatory review as is currently the requirement for Regulation A offerings.

TSX and TSX Venture issuers who rely on Tier 2 of Regulation A+ to offer securities in the United States will be in a better position then issuers who file a full registration statement on Form S-1 or Form F-1.  Offerings under Tier 2 Regulation A+ as proposed will preempt state Blue Sky laws whereas offering under a Form S-1 or Form F-1 registration statement are subject to state blue sky securities laws in each jurisdiction the issuer intends to sell securities.

Secondary Trading and State Blue Sky Laws

Although offerings under Tier 2 of Regulation A+ as proposed are exempt from state Blue Sky laws; the secondary trading of securities received by purchasers in the offering will be subject to state Blue Sky laws. This is an awkward result. Holders of securities must have a secondary trading exemption in order to sell their securities.

Holders wishing to sell must find a state secondary trading exemption if the securities they holder are not listed on an SEC designated exchange under NSMIA. These exemptions are limited.

Also, if a secondary trading exemption is not available, broker-dealers and investment advisors cannot give advice or provide research reports relating to that security to investors in that state. Broker-dealers are also reluctant to rely on the exemption for isolated non-issuer transaction (available in every state but New York). If an investor claims he or she was solicited or offered advice on the sale the broker-dealer may find themselves in arbitration proceeding for rescission or damages.

The chart below has been recreated from a chart included in the OTC Markets Group Inc.’s March 2014 comment letter to the SEC.[3] It shows the secondary trading Blue Sky compliance of a variety of various issuers, including TSX and TSX Venture issuers.

Blue Sky Compliance for Secondary Trading

(As of March 24, 2014)

All Securities with Blue Sky Data Available OTCQX Securities SEC Reporting Issuers Alternative Reporting Standard Issuers TSX Venture Exchange Listed Issuers Toronto Stock Exchange Listed Issuers OTCQX ADRs (Includes FTSE All World Index> OTCQX ADRs (Non-FTSE)
Total # of Securities 395 334 67 22 61 112 58 61
Average # of Jurisdictions in Compliance 41.27 41.93 46.03 30.36 42.39 39.53 45.75 40.14
Average Population Coverage 78.83% 80.16% 88.6 71 56% 76.87% 74.63% 93.90% 76.7 71
State/ Jurisdiction % in Compliance % in Compliance % in Compliance % in Compliance % in Compliance % in Compliance % in Compliance % in Compliance
Alaska 93.40% 97.00% 91.20% 77.30% 93.40% 97.30% 98.30% 98.40%
Alabama 35.20% 31.40% 86.00% 4.50% 14.80% 4.50% 8970% 27.90%
Arkansas 94.50% 97.00% 91.20% 72.70% 93.40% 97.30% 98.30% 98.40%
Arizona 75.90% 79.30% 91.20% 40.90% 80.30% 76.80% 91.40% 67.20%
California 32.20% 26.60% 86.00% 9.10% 9.80% 4.50% 96.60% 14.80%
Colorado 93.70% 98.20% 91.20% 68.20% 95.10% 98.20% 98.30% 100.00%
Connecticut 65.60% 66.20% 87.70% 59.10% 59.00% 34.80% 100.00% 90.20%
District of Columbia 92.70% 96.70% 89.50% 72.70% 93.40% 97.30% 98.30% 98.40%
Delaware 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Florida 93.40% 97.00% 91.20% 77.30% 93.40% 97.30% 98.30% 98.40%
Georgia 92.70% 96.70% 91.20% 45.50% 100.00% 97.30% 98.30% 98.40%
Guam 0.30% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Hawaii 43.30% 26.60% 91.20% 9.10% 100.00% 5.40% 0.00% 0.00%
Iowa 94.70% 98.20% 91.20% 77.30% 100.00% 97.30% 98.30% 98.40%
Idaho 92.20% 96.70% 91.20% 45.50% 100.00% 97.30% 98.30% 98.40%
Illinois 87.60% 91.00% 86.00% 4.50% 96.70% 91.10% 94.80% 95.10%
Indiana 94.70% 98.20% 91.20% 77.30% 100.00% 97.30% 98.30% 98.40%
Kansas 89.10% 92.20% 87.70% 77.30% 100.00% 82.30% 98.30% 98.40%
Kentucky 13.70% 9.00% 86.00% 9.10% 3.30% 4.50% 0.00% 0.00%
Louisiana 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Massachusetts 93.40% 97.00% 91.20% 77.30% 93.40% 97.30% 98.30% 98.40%
Maryland 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Maine 95.90% 98.20% 91.20% 77.30% 100.00% 97.30% 98.30% 98.40%
Michigan 94.20% 98.20% 91.20% 72.70% 100.00% 97.30% 98.30% 98.40%
Minnesota 94.20% 98.20% 91.20% 72.20% 100.00% 97.30% 98.30% 98.40%
Missouri 74.70% 76.30% 91.20% 13.60% 100.00% 88.40% 86.20% 31.10%
Mississippi 94.20% 98.20% 91.20% 72.70% 100.00% 97.30% 98.30% 98.40%
Montana 30.40% 34.40% 3.50% 4.50% 34.40% 3.60% 96.60% 54.10%
North Carolina 79.70% 82.30% 91.20% 63.60% 80.30% 75.00% 96.60% 98.40%
North Dakota 29.10% 9.60% 80.70% 40.90% 3.30% 0.90% 0.00% 0.00%
New England 93.40% 97.00% 91.20% 77.30% 93.40% 97.30% 98.30% 98.40%
New Hampshire 0.50% 0.30% 1.80% 0.00% 0.00% 0.90% 0.00% 0.00%
New Jersey 93.70% 97.00% 93.00% 77.30% 93.40% 97.30% 98.30% 98.40%
New Mexico 94.70% 98.50% 91.20% 77.30% 100.00% 97.30% 100.00% 98.40%
Nevada 60.30% 60.50% 87.70% 36.40% 52.50% 32.10% 96.60% 80.30%
New York 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Ohio 93.90% 97.90% 89.50% 77.30% 95.10% 98.20% 98.30% 100.00%
Oklahoma 59.70% 61.70% 86.00% 4.50% 100.00% 22.30% 96.60% 68.90%
Oregon 72.20% 72.50% 78.90% 72.70% 67.20% 45.50% 98.30% 98.40%
Pennsylvania 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Puerto Rico 58.00% 62.30% 50.90% 36.40% 73.80% 76.80% 43.10% 42.60%
Rhode Island 93.70% 97.00% 93.00% 77.30% 91.80% 97.30% 98.30% 98.40%
South Carolina 94.70% 98.20% 91.20% 77.30% 100.00% 97.30% 98.30% 98.40%
South Dakota 94.70% 98.20% 91.20% 77.30% 100.00% 97.30% 98.30% 98.40%
Tennessee 89.90% 96.10% 86.00% 9.10% 100.00% 99.10% 98.30% 100.00%
Texas 86.60% 93.40% 64.90% 68.20% 90.20% 92.90% 98.30% 100.00%
Utah 31.60% 29.00% 86.00% 4.5% 8.20% 4.50% 96.60% 14.80%
Virginia 28.90% 26.00% 86.00% 4.5% 6.60% 4.50% 89.70% 6.60%
Virgin Islands 43.30% 26.60% 91.20% 9.10% 100.00% 5.40% 0.00% 0.00%
Vermont 91.90% 96.40% 89.50% 45.50% 100.00% 97.30% 98.3 71 98.40%
Washington 97.50% 98.20% 98.20% 100.00% 100.00% 97.30% 98.30% 98.40%
Wisconsin 95.70% 99.40% 91.20% 77.30 100.00% 100.00% 98.30% 98.40%
West Virginia 73.70% 67.70% 91.20% 68.20% 78.70% 76.80% 43.10% 42.60%
Wyoming 94.70% 98.20% 93.00% 77.30% 95.10% 98.20% 98.30% 100.00%

Closing Remarks

Regulation A+ will offer certain Issuers, including those listed on the TSX and TSX Venture Exchange, with a new effective way to raise capital in the United States.  Tier 2 of Regulation A+ is likely to become as popular as Regulation D Rule 506 in raising capital.  Unfortunately, holders of securities will still be hampered by Blue Sky compliance issues for secondary trading.


Notes:

  1. Ivanov, Vladimir and Bauguess, Scott. (2013, July). Capital Raising in the U.S.: An Analysis of Unregistered Offerings Using the Regulation D Exemption, 20019 – 2012,  U.S. Securities and Exchange Commission – Division of Economic and Risk Analysis.
  2. The limitations of Regulation A and the specifics and opportunities of proposed Regulation A+ have been discussed in prior blog articles.  See: (1) Cormick, Alixe ( 2014, April 30). Welcome to Canada! Using Regulation A+ to List on the CSE, TSX or TSX Venture Exchange, blog; and (2)  Cormick, Alixe. (2013, December 18). A Canadian Perspective on the New U.S. Regulation A Exemption, blog.
  3. Zinn, Daniel. (2014, March 24).  Comment Letter of General Counsel of OTC Markets Group Inc. to SEC Re: Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act. Chart based on Appendix A to comment letter.
Alixe Cormick is the founder of Venture Law Corporation in Vancouver, British Columbia and a member of Commercialization Advisory Board of the Life Science Institute at the University of British Columbia, the Advisory Board of the National Crowdfunding Association and two private tech companies. She is also a member of the Pacific Northwest Keiretsu Forum, an association of accredited private equity angel investors, venture capitalists and corporate/institutional investors, and Vantech Angel Technology Network, a Vancouver angel group. You can reach Alixe by phone at 604-659-9188, by email at acormick@venturelawcorp.com, on twitter at @AlixeCormick or on Google+ at +AlixeCormick.
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Blue Sky Compliance for Secondary Trading: Proposed Regulation A+ Highlights Ongoing Issue
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Securities offered under Tier 2 of Regulation A+ are exempt from state Blue Sky laws. The secondary trading of these securities is not. Why this awkward result?
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Venture Law Corporation
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