Brian Knight
Associate Director, Financial Policy, Center for Financial Markets
Banking and Business and Capital Access and Capital Markets and Finance and Financial Innovations and FinTech and Global Economy and Job Creation and Public Policy and Regulation and U.S. Economy
Brian Knight is an attorney with significant experience in new sources of capital, financial technology, and entrepreneurial issues. He is interested in the interplay between technological, regulatory, and market innovation and how best to improve access to capital for businesses of all sizes.
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Is This the End for Reg. A+?

By: Brian Knight
May 27, 2015

On May 22nd William Galvin, Secretary of the Commonwealth of Massachusetts, who serves as the Commonwealth’s chief securities regulator, as well as the government of Montana, filed suits against the SEC to stop the implementation of the recent “Reg. A+” rules. The complaints ask the U.S. Court of Appeals for the District of Columbia Circuit to vacate the rule and issue an injunction against its going into effect.  While the complaint does not specify what part of the Reg. A+ rules Galvin objects to, media reports indicate that he is livid that the SEC excluded state regulators from reviewing “Tier 2” offerings, an act viewed by many as essential to make Reg. A viable, but one that was not explicitly authorized by Congress in the JOBS Act. Galvin’s view is that, given that Congress could have explicitly preempted the states in Title IV of the JOBS Act (like they did in Title III) and chose not to, the SEC exceeded its authority by preempting the states, making the rule invalid. (Montana’s complain was not available at the time of writing).

So what does this mean? It means that Regulation A+, at least the part that provides for state preemption (and the part that is more likely to actually be attractive to companies seeking investment), may be dead in the water. First, Montana is specifically asking for it to be stopped immediately via an injunction, which the court may grant while the case is litigated. Second, even if the court refuses to grant an injunction, the ultimate fate of any offering made under Tier 2 while litigation is ongoing is uncertain, because if Galvin or Montana win, the offerings made without state approval are presumably incomplete and invalid. This ambiguity will likely cause companies to hold off of pursuing Regulation A+ until they have certainty.

The best* hope for Reg. A+ to take effect on time is for the Court to dismiss the complaints immediately. This is highly unlikely because there is at least a colorable argument that the SEC exceeded its authority. But this does not mean that this case is a slam-dunk for Galvin or Montana. While it is true that Congress didn’t explicitly preempt the states in the Regulation A+ portion of the JOBS Act, Congress has provided the SEC with preemptive authority in other statutes, including the Securities Act of 1933 on which the SEC relied in Regulation A. As such, it may not matter that Congress didn’t explicitly preempt the states, since it arguably empowered the SEC to make those decisions on its own. Absent an obvious answer, it is likely that this case will go to trial, delaying, and possibly eliminating Regulation A+.

Ultimately this highlights the need for Congress to be explicit and proactive in creating laws that enable innovation and modernization in the economy. Galvin and Montana are not villains – they are acting to preserve what they sees as their ability to protect their citizens.

The big-picture problem is that state-by-state regulation of online offerings is fatal to their success. Modern technology has eliminated the burden of distance and made these offerings interstate commerce as a matter of course. Companies seeking investment can communicate with people all over the country (or the world), and it would require a conscious choice by a company to limit the scope of its offering to only one state.

In this environment, Congress is the proper body to set the rules, and it should do so clearly to avoid ambiguity and confusion. Failure is going to lead to more problems like this one, where there are legitimate questions about what the rules are, and where people and companies, fearing they will guess wrong, will freeze and do nothing. Regulatory uncertainty is toxic to prosperity.

*Of course, if Congress and the President wanted to, they could resolve this now by passing a law providing explicit state preemption in Regulation A+, but I’m not going to hold my breath.