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From Securities Regulation Daily, September 3, 2015

Reg A+ contrary to congressional intent, NASAA argues

By John M. Jascob, J.D., LL.M.

The SEC exceeded its delegated authority by preempting state review of Regulation A offerings, NASAA has argued. In an amicus brief filed on behalf of two state securities regulators who are challenging the rule, NASAA contends that the Commission has ignored congressional intent by defining “qualified purchaser” in such a way as to expand the exemption beyond the clear language of the JOBS Act. Separately, eight current and former members of Congress, including Rep. Maxine Waters (D-Cal) and former Rep. Barney Frank (D-Mass), also filed an amicus brief asking the court to vacate the rule (Lindeen v. SEC and Galvin v. SEC, September 2, 2015).

State petitions. In late May, securities administrators from the states of Massachusetts and Montana each filed petitions with the Court of Appeals for the District of Columbia Circuit, asking the court to review the legality of Regulation A+. Adopted by the SEC under the mandate of the JOBS Act on March 25, the rule raises the dollar limit for smaller offerings that are exempt from Securities Act registration. The rule created two tiers of offerings while preempting Tier 2 offerings of up to $50 million from state regulation. Officials from both states argued that the rule is arbitrary, capricious, and otherwise not in accordance with the Administrative Procedure Act, the Securities Act, and other law. Montana sought a stay of the rule and Massachusetts requested vacatur of the rule and a permanent injunction prohibiting the SEC from implementing and enforcing the rule.

Undermining the state-federal framework. In NASAA’s view, the scope of preemption in the Commission’s final rule undermines the joint state-federal regulatory framework that has existed since Congress enacted the first federal securities legislation in 1933. NASAA noted that throughout the years, Congress has continually recognized and preserved the critical role of state regulation in this dual structure. When Congress has determined that the historical balance between state and federal legislation needed adjusting, such as in the National Securities Markets Improvement Act of 1996 (NSMIA), it has always made clear its intention to preempt state law and narrowly tailored such preemption to uphold the investor protections afforded by state regulation. NASAA believes that the SEC’s final rule has usurped the authority of Congress and disrupted this balance without a clear mandate to do so.

Definition of “qualified purchaser.” Specifically, NASAA contends that the SEC has exceeded its authority by defining “qualified purchaser”—a concept first introduced into the federal securities laws by NSMIA—in a manner that improperly expands the preemptive reach of the Regulation A exemption beyond the clear language and intent of the JOBS Act and NSMIA. NASAA noted that the Commission’s final rule defines “qualified purchaser” as “any person to whom securities are offered or sold pursuant to a Tier 2 offering of this Regulation A.” Although acknowledging that Congress has unquestionably authorized the Commission to define “qualified purchaser,” NASAA believes that the Commission has exceeded its delegated authority by effectively removing the word “qualified” from the statute.

NASAA observed that under the Chevron test for evaluating an agency’s interpretation of a statute that it administers, the first step always concerns whether Congress has directly spoken to the precise question at issue.  Here, Congress' unambiguous use of the word “qualified” to modify “purchaser" mandates that the Commission define the term “qualified purchaser” to include substantive requirements for purchasers. In contrast, the SEC’s definition erases the word “qualified” from the statute by defining the term to mean any purchaser, thereby exceeding the SEC’s delegated authority.

Moreover, even if the JOBS Act had contained ambiguity, the Commission’s interpretation would still be unreasonable under Chevron step two, NASAA argued. In NASAA’s view, the Commission’s definition of “qualified purchaser” thwarts Congress’ intent to limit federal preemption and preserve the joint regulatory framework for Regulation A offerings by creating blanket federal preemption for any participant in a Tier 2 offering, regardless of any substantive qualifying factors.

Inadequate cost benefit analysis. NASAA also argued that the SEC’s cost benefit analysis failed to assess adequately the impact of state efforts to reduce costs to issuers.  In particular, NASAA believes that the Commission failed to adequately consider the lower costs and ease of use of NASAA’s streamlined Coordinated Review Program for Regulation A Offerings, which has now been approved by 50 U.S. jurisdictions. Although the SEC relied heavily on a 2012 GAO report indicating that the costs of state law compliance could be one factor discouraging the use of Regulation A, the Commission largely ignored the fact that the Coordinated Review Program effectively addresses the concerns raised in the GAO report, NASAA stated. For example, NASAA noted that the Commission appears to have completely disregarded the comments of one issuer, Groundfloor Finance, Inc., that participated in the Coordinated Review Program and greatly extolled its benefits.

NASAA also took the SEC to task for failing to fully consider the costs associated with removing the investor protections offered by state-level review in the area of small and thinly traded company offerings. Although the Commission claimed it could not determine how the elimination of state registration requirements will affect the incidence of fraud, NASAA noted that analogous data should be readily available to the Commission in light of investors’ experience with preemption and microcap issuers in the Regulation D context. NASAA pointed out that Rule 506 offerings have been the single most common investment product or scheme involved in state enforcement actions over the past three years. Moreover, NASAA believes that the Commission failed to provide an adequate or reasoned response to concerns that the Commission does not have the resources to adequately review Regulation A offerings. As a result, the Commission’s review will either be shortcut at the expense of investors or too protracted to timely serve the needs of the issuer, NASAA argued.

Congressional views. In their amicus brief, the eight current and former members of Congress also argued that the SEC’s decision to preempt state review of Regulation A offerings was contrary to the intent of Congress. The amici noted that Congress debated at length and affirmatively rejected provisions in the JOBS Act that would have generally preempted the states’ authority to review and qualify Regulation A+ offerings. Fox example, the House of Representatives voted on an overwhelmingly bipartisan basis, 421-1, to reject legislation that would have broadly preempted state authority to review and qualify Regulation A+ securities sold to ordinary investors through a broker or dealer. Instead, Congress opted to permit only a narrow, tailored preemption for securities sold to a small universe of sophisticated investors who are deemed to be “qualified purchasers” by the SEC and for securities that are listed on an exchange.

The SEC’s final rule, however, imposes precisely the type of broad preemption of state authority that Congress decisively rejected. By adopting a rule that effectively defines any purchaser of a Regulation A+ security as a “qualified purchaser,” irrespective of such investor’s circumstances or sophistication, the Commission effectively preempted all state authority to review Regulation A+, Tier 2 offerings, the amici observed. In their view, such broad preemption should only occur with the express consent of Congress, and they expressed alarm at the SEC’s decision to promulgate a rule clearly at odds with congressional intent. Given the states’ historic role as the primary regulators of smaller offerings and express congressional intent to preserve the states’ authority over Regulation A+ securities, the amici argued that the SEC has significantly overstepped its authority in broadly defining “qualified purchaser” in the final rule. Accordingly, they urged the court to grant the request to vacate the rule and issue a permanent injunction prohibiting the Commission from implementing and enforcing the rule.

The eight amici filing the brief were Rep. Maxine Waters (D-Cal), Rep. Stephen Lynch (D-Mass), Rep. Keith Ellison (D-Minn), Rep. Michael Capuano (D-Mass), Rep. Carolyn Maloney (D-NY), Rep. Niki Tsongas (D-Mass), Sen. Ed Markey (D-Mass), and former Rep. Barney Frank (D-Mass).

The cases are Nos. 15-1149 and 15-1150.

Attorneys: Jesse Laslovich, Office of the Commissioner of Securities and Insurance, for Monica J. Lindeen, Montana State Auditor, ex officio Montana Commissioner of Securities and Insurance. Jeffrey Alan Berger for the SEC.

MainStory: TopStory JOBSAct SecuritiesOfferings NewsFeed DistrictofColumbiaNews MassachusettsNews MontanaNews

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