D.C. Circuit Rejects Challenge to SEC Regulation A+

The Commission prevailed in the D.C. Circuit which rejected a challenge to Regulation A+. Petitioners, the chief security regulators for Massachusetts and Montana argued that the SEC’s rules were contrary to the Supreme Court’s decision in Chevron, U.S.A. Inc. v. Natural Resources Defense Counsel, Inc., 467 U.S. 837 (1984). The challenges focused on the preemption of state securities registration requirements.

Regulation A, enacted in 1936, permitted a firm to file a simplified offering statement for raising certain amounts of money in the capital markets. The point was to ease the cost of registration. Investor protections came in three forms: 1) prior to sale the SEC staff “qualified” the offering statement; 2) the issuer was obligated to deliver the offering circular to investors prior to sale; and 3) the antifraud provisions. Section 3(b) of the Securities Act exempted Regulation A offerings from federal but not state registration requirements. The provision was not widely used.

The JOBS Act of 2012 added Section 3(b)(2) to the Securities Act. It directed the SEC to enact a rule exempting a new class of securities from registration such as offering up to $50 million. One provision specified that some of the securities issued under the new regulation were to be exempt from state registration requirements. This included those sold on a national securities exchange or to qualified purchasers as defined by the SEC. The SEC was given authority to create other requirements deemed necessary to advance the public interest and for investor protection. The Comptroller General was directed to conduct a study within three months of the impact on state securities regulation.

The SEC’s proposed rules for what is known as Regulation A+ had two tiers: Tier 1 was for offering up to $5 million and was substantially similar to the original Regulation A. Tier 2 would apply to offerings up to $50 million and included certain additional investor safeguards. In part those protections included a requirement for audited financial statements. The also included a proposal limiting purchases to 10% of the investor’s annual income or net worth, whichever is greater. In the final rule the Commission defined qualified purchaser as any person to whom “securities are offered or sold pursuant to a Tier-2 offering . . .” Regulation A+ preempted all state registration requirements for an accredited investor or purchases by anyone else “so long as the non-accredited investor refrained from purchasing securities valued at no more than 10% of his net worth or annual income.”

Petitioners claim that the term qualified purchaser cannot mean “any” person but must be limited to those with sufficient financial wealth or sophistication to invest without state-law safeguards. To read the rule otherwise is contrary to Chevron in their view. The court found otherwise.

First, Petitioners’ must demonstrate under Chevron that the text of the statute forecloses the position adopted by the SEC. Stated differently, they must demonstrate that the adopted regulation is outside the scope of authority delegated to the Commission by Congress. Here it is not. The statutory text does not specifically address the question presented here regarding the meaning of qualified purchaser in relation to state preemption. “Instead, the Congress explicitly authorized the Commission to define the term . . . Congress intended the SEC to enjoy broad discretion to decide who may purchase which securities without the encumbrance of state registration . . .” the court found.

Nevertheless, Petitions contend that the term “qualified purchaser” cannot include “all,” that the SEC was required to craft a definition tied to investor wealth and experience, and that all of this is supported by the legislative history. Whatever the appeal of these arguments, the court noted, “even the most formidable argument concerning the statute’s purposes [cannot] overcome the clarity [found] in the statute’s text” (internal citations omitted). Since Regulation A+ does not conflict with the unambiguous intent of Congres,s it does not fail Step 1 of Chevron.

Second, Petitioners’ claim that the qualified purchaser definition is unreasonable and therefore fails Chevron Step 2. Under this prong of the test the court stated that “we defer to the Commission so long as its definition is ‘based on a permissible construction of the statute,’” quoting Chevron, 467 U.S. at 842-43. Where, as here, there is a specific delegation to the agency its determination is given “controlling weight” unless it is “arbitrary, capricious, or manifestly contrary to the statute.” Here it is not. To the contrary, the SEC acted within the scope of its authority under the statute.

Nevertheless, Petitioners claim to have met the requirements of Chevron Step 2 because there should be a presumption against preemption, the SEC failed to provide a reasoned explanation for its definition and since the agency did not explain the changes from the proposed to the final regulation in the definition. The court rejected each claim. First, the decision of Congress to exempt qualified purchasers from state regulation was “clear and manifest” as was its decision “to authorize the SEC . . . to determine the scope of state preemption . . .” Second, the SEC did in fact explain how its final rules will provide for a meaningful addition to capital formation options for small companies. Finally, an agency is permitted to consider various alternatives in rule writing and, in any event, the SEC adequately explained the predicate for its final approach in the context of the JOBS Act which is what was required. Accordingly, the “Commission’s qualified-purchaser definition is not ‘arbitrary, capricious, or manifestly contrary to the statute” within the meaning of Chevron.