The JOBS Act enacted in 2012 made the most dramatic changes to the landscape for the marketing and selling of both private and public offerings since the enactment of the Securities Act of 1933. These significant changes include: (i) the creation of Rule 506(c), which came into effect on September 23, 2013 and allows for general solicitation and advertising in private offerings where the purchasers are limited to accredited investors; (ii) the overhaul of Regulation A creating two tiers of offerings, which came into effect on June 19, 2015 and allows for both pre-filing and post-filing marketing of an offering, called “testing the waters”; (iii) the addition of Section 5(d) of the Securities Act, which came into effect in April 2012, permitting emerging growth companies to test the waters by engaging in pre- and post-filing communications with qualified institutional buyers or institutions that are accredited investors; and (iv) Title III crowdfunding, which came into effect May 19, 2016 and allows for the use of Internet-based marketing and sales of securities offerings.
This two-part blog series focuses on test-the-waters marketing of Regulation A/A+ offerings and Section 5(d) for public offerings by emerging growth companies. Part I discussed Regulation A/A+ and Part II discusses Section 5(d) for IPO’s by emerging growth companies.
Test The Waters In Regulation A/A+ Offerings
On June 19, 2015 the new rules for Regulation A/A+ came into effect.  Regulation A was divided into two tiers: Tier I Regulation A, which does not preempt state law, allows offerings of up to $20 million in any 12-month period and Tier 2, which does preempt state law, allows offerings of up to $50 million in any 12-month period. Issuers may elect to proceed under either Tier I or Tier 2 for offerings up to $20 million. Since enactment of the rules, the SEC has issued guidance via Compliance and Disclosure Interpretations (C&DI) and industry participants have guided each other, communicating about experiences, successes and frustrations.
Regulation A+ allows for prequalification solicitations of interest in an offering, commonly referred to as “testing the waters.” As mentioned above, Tier 1 offerings do not preempt state law and accordingly, any issues intending to test the waters for a Tier 1 offering must comply with the individual state law(s) in which they intend to qualify the offering.  This process can be expensive and tricky and as such, the vast majority of Regulation A+ offerings have been filed under Tier 2 and almost all, if not all, test-the-waters campaigns are for Tier 2 offerings. This initial discussion assumes a Tier 2 offering, though I will touch on Tier 1 below as well.
Issuers can use “test-the-waters” solicitation materials both before and after the initial filing of the Form 1-A registration statement. In the event that materials are issued after the filing of the Form 1-A, the materials must include Form 1-A itself or information on where one can be obtained. This requirement is satisfied by providing a link to the Form 1-A filing on the EDGAR database.
Moreover, solicitation material used before qualification of the Form 1-A must contain a legend stating that no money or consideration is being solicited and none will be accepted, no offer to buy securities can be accepted and any offer can be withdrawn before qualification, and a person’s indication of interest does not create a commitment to purchase securities.
Generally a test-the-waters legend appears on the bottom of a webpage or on the first page of a PowerPoint or other investor deck. An example of a disclosure utilized prior to the filing of a Form 1-A would be:
No money or other consideration is being solicited for our Regulation A+ offering at this time and if sent in to Acme, Inc. will not be accepted. No offer to buy securities in a Regulation A+ offering of Acme can be accepted and no part of the purchase price can be received until Acme’s offering statement is qualified with the SEC. Any such offer to buy securities may be withdrawn or revoked, without obligation or commitment of any kind, at any time before notice of its acceptance given after the qualification date. Any indications of interest in Acme’s offering involves no obligation or commitment of any kind.
In addition to the above pre-filing disclosure, I often see and use an added disclosure similar to the following:
Acme Inc. is testing the waters under Regulation A of the Securities Act of 1933, as amended. This process allows companies to determine whether there may be interest in an eventual offering of its securities. Acme is not under any obligation to make an offering under Regulation A. Acme may choose to make an offering to some, but not all, of the people who indicate an interest in investing, and that offering may not be made under Regulation A. For example, Acme may determine to proceed with an offering under Rule 506(c) of Regulation D, in which case we will only offer our securities to accredited investors as defined by Rule 501(a) of Regulation D. If Acme does go ahead with an offering under Regulation A, it will only be able to make sales after it has filed an offering statement with the Securities and Exchange Commission (“SEC”) and only after the SEC has qualified such offering statement. The information in the offering statement will be more complete than the test-the-waters materials and could differ in important ways. You must read the offering statement filed with the SEC.
The disclaimer legend for testing-the-waters materials utilized following the filing of a Form 1-A with the SEC will be substantially the same, but will contain a link to the filed preliminary Form 1-A on the SEC EDGAR database.
“Test-the-waters” solicitations may be made both orally and in writing.
All solicitation material must be submitted to the SEC as an Exhibit under Part III of Form 1-A. This is a significant difference from S-1 filers, who are not required to file “test-the-waters” communications with the SEC.
Unlike the “testing of the waters” by emerging growth companies that are limited to QIBs and accredited investors, a Regulation A+ company could reach out to retail and non-accredited investors. After the public filing but before SEC qualification, a company may use its preliminary offering circular to make written offers.
Of course, all “test-the-waters” materials are subject to the antifraud provisions of federal securities laws.
Like registered offerings, ongoing regularly released factual business communications, not including information related to the offering of securities, will be allowed and will not be considered solicitation materials.
On June 23, 2015, the SEC updated its Division of Corporation Finance C&DI to provide guidance related to Regulation A/A+ including guidance on testing the waters. In particular, the SEC provided the following guidance related to testing the waters using social media:
A company can use Twitter and other social media that limit the number of characters in a communication, to test the waters as long as the company provides a hyperlink to the required disclaimers. In particular, a company can use a hyperlink to satisfy the disclosure and disclaimer requirements in Rule 255 as long as (i) the electronic communication is distributed through a platform that has technological limitations on the number of characters or amount of text that may be included in the communication; (ii) including the entire disclaimer and other required disclosures would exceed the character limit on that particular platform; and (iii) the communication has an active hyperlink to the required disclaimers and disclosures and, where possible, prominently conveys, through introductory language or otherwise, that important or required information is provided through the hyperlink.
Practical Considerations
In addition to the legal aspects of testing the waters, a company needs to consider the practical business aspects as well, including whether they should test the waters at all. I’ve engaged in quite a bit of healthy discussion on the topic, and read just as much.
Testing the waters can be very helpful in determining whether proceeding with a Regulation A offering is the right course for a company.  A Regulation A offering is not inexpensive. A company needs to complete an audit, incur legal fees and incur direct and indirect marketing and offering expenses. In addition to the direct offering expenses, management will need to focus an inordinate amount of time on the offering itself, which time will detract from business operations.
Testing the waters can also help to build up investor interest and excitement for an offering prior to its actual launch or “going live,” thus making the selling process exponentially quicker and easier. It takes time to educate the public about a company and an offering, and through testing the waters, this process can be completed concurrently with the SEC review of the Form 1-A rather than after. Moreover, testing the waters may have the secondary effect of increasing product sales, customer acquisition and brand awareness.
Keep in mind that a successful test-the-waters process does not ensure a successful offering. Although the process is still new, so far less than 50% of potential investors that indicate interest in an offering actually follow through with an investment. That figure may actually be far lower. I’ve read at least one credible source who believes that the conversion from a test-the-waters indication of interest to an actual investment is closer to 5%.
As with all matters, there is a counter to the positive. An ill-prepared or poorly executed test-the-waters campaign may prove extremely detrimental to what may otherwise have been a successful offering process. I have seen some companies attempt to test the waters without any legal or other guidance whatsoever, through social media or their own websites. These campaigns generally are not only unsuccessful but present a poor public image of the company. In this case, a company may need to pull all offering plans for a “cooling-off period” before launching again with better guidance.
As with all public offering matters, a company must also consider the public availability of test-the-waters materials, and education for competitors, including knowledge of the offering itself. To me this is less of a consideration; if a company does not want a competitor to learn of their business and offering plans, a Regulation A public offering is probably not the right choice in the first place. That company may be better suited filing a confidential registration statement on Form S-1 or sticking with private offerings.
Once a company determines to proceed with testing the waters, preparation is key. A company and its advisors need to prepare materials that are not only creatively compelling from a general marketing standpoint but that are also compelling to a reasonably sophisticated investor. That requires researching recent deal flow from the same and similar industry groups, as well as knowing what deal parameters have been successful and what have not and understanding the constantly changing investor appetite.
A company must also consider who it is directing its campaign towards. A different approach may be used when soliciting a long-standing customer or fan base with prior knowledge of a business, than for a list of broker-dealer clients that have never heard of the company before.
State Law Concerns
Tier 1 offerings do not preempt state law and accordingly, any issues intending to test the waters for a Tier 1 offering must comply with the individual state law(s) in which they intend to qualify the offering. This process can be expensive and tricky and as such, the vast majority of Regulation A+ offerings have been filed under Tier 2 and almost all, if not all, test-the-waters campaigns are for Tier 2 offerings.
Although a Tier 2 offering does not require state registration and review, the individual states specifically maintain the right and jurisdiction to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by an issuer, related party or any broker, dealer or funding portal in any transaction. Moreover, the states can require a notice filing requirement. The law specifically allows the states to require a copy of any document filed with the SEC, together with annual or periodic reports of the value of securities sold or offered to be sold to persons located in the state (if not already included in the SEC filing) as long as such filing is solely for notice purposes and for the assessment or calculation of a fee. States may also require the filing of consent to service of process.
States may also require the payment of a fee in connection with a notice filing, except when fees are specifically prohibited in connection with securities that are listed or authorized for listing on a national securities exchange such as the NYSE or NASDAQ. No Regulation A offerings have been completed resulting in a security trading on a national exchange as of the date of this blog, but it is legally possible and I suspect will happen. Although a state may not condition the federal preemption granted by the federal law upon the payment of a fee, it can suspend an otherwise covered offering in its state for the failure to file a notice filing and pay the fee.
The timing and fees associated with blue sky notice filings vary. Accordingly, even for covered securities, a review of state blue sky laws is necessary.
As a result of potential blue sky issues when testing the waters under Tier 2, for prequalification test-the-waters materials, I often use an added disclaimer as follows:
No offer to sell securities or solicitation of an offer to buy securities is being made in any state where such offer or sale is not permitted under the blue sky or state securities laws thereof. No offering is being made to individual investors unless and until the offering has been registered in that state or an exemption from registration exists. Acme, Inc. intends to complete an offering under Tier 2 of Regulation A and as such intends to be exempted from state registration pursuant to federal law. Although an exemption from registration under state law may be available, Acme may still be required to provide a notice filing and pay a fee in individual states.
For a review of federal preemption of state securities laws, see my two-part blog on the National Markets Improvement Act of 1996 (NSMIA) HERE and HERE. Note that these blogs were written prior to the adoption of the new Regulation A rules and do not take into account the addition of Regulation A Tier 2 offerings as a “covered security.”
Also, as I have previously written about, even when an offering is preempted from state blue sky laws, the ability to sell the offering may not be. In particular, the NSMIA offering preemption law does not preempt broker-dealer registration requirements associated with such offering. At least two states, Florida and New York, do not provide exemptions for issuers who self-underwrite or self-place public offerings. A Regulation A offering is a public offering. For more information on these issues and Florida and New York in particular, please see my blog HERE. Note that following the publication of that blog, Florida has passed an exemption from the broker-dealer registration requirements for merger and acquisition brokers similar to the federal exemption. I will be writing about Florida’s new broker-dealer exemption in an upcoming blog.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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