REG A+: A Risk/Reward Perspective for CPA Firms

While there are a multitude of differences between the two, the most interesting differences for an accounting firm have been collected below:

Issue	Tier I	Tier II
Maximum capital to raise	Less than $20 million	$20 million–$50 million
State blue sky registration	Yes	No
Unaccredited investors allowed?	Yes (no limit on purchases)	Yes (limited to 10% of their annual income or net worth or annual revenue, unless the security is listed on a national exchange)
Offering statement	Unaudited financial Statements, unless financial statements audited by an independent auditor are available.	Financial Statements audited by an SEC independent auditor. (The audit must be in accordance with either US GAAS or PCAOB.)
Estimated total cost	$50K–75K	$75K–$150K

How large of an opportunity is this? There are approximately 27 million companies in the United States, but less than 1% of those are currently traded publicly. Those 27 million private companies account for an estimated $75 trillion in market cap. To put that number into perspective, the combined value of the Shanghai and Shenzhen Stock Exchanges was worth roughly $10 trillion in 2015.

Potential Rewards

Tier II companies will require annual financial statements audited in accordance with GAAS or PCAOB standards. Given the risk/reward calculus of any engagement, it is most likely that your firm would engage in a Tier II offering, due to the higher engagement cost of audited financial statements as opposed to a lower engagement cost for simply reviewing financial statements in a Tier I offering. However, your firm may require these Tier I issuers to forgo a review in favor of a full audit.

Sue Holl, a long-time CPA and the Vice President of Loss Prevention at CAMICO, had this to say:

“My sense is that it will be difficult for Tier I issuers to find firms willing to perform anything less

than an audit, given the risk versus reward scale[.] Tier I issuers may find themselves needing to

agree to have audited financials and engaging firms for those services.”

      Unlike a traditional SEC-registered company, Tier II will require fewer annual Form 1-K items, and they have done away with the quarterly Form 10-Q in favor of a semi-annual Form 1-SA. Also, they are subject to fewer triggering events in a Form 1-U when compared to the traditional Form 8-K. These reporting requirements will remain in place for at least one year after the offering has been qualified and for as long as the offer is ongoing. Upon completion of the offering, both tiers will be required to file a form upon the termination of their offering.

Before you think that this will bring a panacea of additional billable services to your firm, don’t forget about the SEC’s independence rules set forth in Rule 2-01 of Regulation S-X. Any “non- audit services” may require pre-approval by the issuer’s audit committee, or you may be judged as having your independence impaired.

Historically, pre-IPO investors were limited to venture capital, private equity, and angel investors.

Nationwide, only 3% of Americans meet the eligibility requirements to become an accredited investor under the guidelines of the SEC. This limited deregulation could open the floodgates to the remaining 97% of Americans. With such a large investor base, you could have a large number of fast-growing clients, increasing the demand for your services both directly and indirectly.

      Additionally, Reg A+ companies can transition at some point to becoming full-fledged SEC-registered public companies; a significant source of revenue for your firm. Indeed, it may be beneficial to have a Reg A+ offering prior to a full-on IPO for a number of technical reasons, beyond the scope of this article. If your firm is already involved in providing services to publicly traded clients or is looking to do so in the future, this could be a good half-measure to that end.

Potential Dangers

      Unlike Tier I offerings, under Tier II offerings (the most likely you would be involved with), states have been preempted from enacting their blue-sky laws. Previously, a company would have to comply with the blue-sky laws of any state within which it wanted to sell its securities. These laws were enacted to protect investors from fraudulent sales practices and/or activities. Following requests of Congress, the SEC exempted Tier II offerings from state blue sky laws, and, as a result, were subsequently sued by both Massachusetts and Montana. William F. Gavin, Chief Securities Regulator for the Secretary of the Commonwealth of Massachusetts had this to say concerning the SEC’s preemption of state Blue Sky Laws:

“We are dismayed and shocked to see that the Commission’s Regulation A-Plus’ proposal includes provisions that preempt the ability of the states to require registration of these offerings and to review them. The states have tackled preemption battles on many fronts, but never before have we found ourselves battling our federal counterpart. Shame on the S.E.C. for this anti-investor proposal. This is a step that puts small retail investors unacceptably at risk. We urge the Commission to remove these provisions from the rule… The lower-tier over-the- counter trading markets for stocks, such as the Pink Sheets Market and the OTCBB, which list stocks of small public companies, are notorious for providing insufficient information to the public and for fraudulent and abusive practices. The Securities Division sees a steady stream of investors who have been harmed by bad practices in those markets.” (emphasis added)

Ultimately, the D.C. Circuit upheld the original rules regulating Reg A+ offerings, though they recognized that such rules, “stripped a layer of state review.” Given recent high-profile implosions of large publicly traded companies, there is certainly room to question the validity and efficacy of each state’s review process. However, until these state sponsored suits are finalized, they bring only increased speculation as to the long-term validity of the Tier II process.

      Tier II issuers are also exempt from many other Exchange Act requirements, such as “SEC proxy statement rules; Section 16 reporting by directors, officers and 10% stockholders of ownership and transactions in issuer securities; Section 13 disclosure by 5% stockholders; Regulation FD compliance to prevent selective disclosure of material information; internal financial and disclosure effectiveness controls under the Sarbanes-Oxley Act; and CEO/CFO certifications required by Sarbanes-Oxley for periodic reports.” While an unaccredited investor would be unlikely to miss these requirements and disclosures, it may provide increased leeway for an offering company to run fast and loose with its balance sheets.

In response to this uncertainty, AIG Insurance launched a crowdfunding insurance product that allegedly, “protects investors against the theft of issuer assets by issuer directors, officers, or general employees which cause a direct loss to the individual investor.” This coverage apparently protects against misappropriations but not against the lost value in a bad investment, but appears to be unavailable in America. A company with the volume of information and analysis of AIG is certainly not going to insert capital into the market without strong actuarial support. In short, they, too, seem to be waiting until the Reg A+ market in the U.S. matures and stabilizes before they are willing to risk their money on the proposition. A bellwether into the future stability and ongoing health of this area could be the entrance and sustained success of an AIG insurance program in the domestic market.

      Previously, sophisticated investors were presumed to have a basic grasp of market dynamics and be able to withstand a sizeable loss of investment funds without undue hardship. Whether this will hold true for the ranks of unaccredited investors is pure speculation. The danger is that you may now have a group of aficionado investors who, in retrospect, “relied” upon your review or audit as the basis for their investment. If an issuer were to become insolvent or lose significant money, there is no reason to believe that these unaccredited investors won’t go looking for the deepest pockets. It is not unreasonable to assume that a 20% loss for a private equity manager is just a really bad day, but for an unsophisticated investor, it could present significant hardship and trigger a class action lawsuit.

       PwC recently estimated that a company incurs an average cost of 3.7 million attributable to their IPO and

1.5 million in recurring costs to maintain compliance as a public company. By extension, any company willing and able to weather the IPO storm and its subsequent reporting requirements must already have significant growth or market share and a reliable source of income.

The cost for a Reg A+ filing has been estimated at only $40k–$100k, a bargain compared to the previously mentioned costs, which will certainly allow for more entrants into the space.

However, SMBs are, by their very nature, unlikely to have the stability and presence of a large publicly traded company. Whether their small size will allow them to prosper and change direction quickly in the event of adverse market conditions, or simply hasten their demise, is yet to be determined. In short, we just don’t have any reliable metrics as to the long-term viability of Reg A+ issuers.

The revenues that a firm generates from Reg A+ affiliated work would vary based upon region, state, firm size, and firm requirements. An author at the now defunct crowfund.com quoted costs ranging from $12k to $30k. Assuming that you already have proper insurance coverage for this activity (we’ll discuss further below), the additional revenues after your overhead is accounted for may not justify the increased exposure to litigation

To date, roughly nine Reg A+ offerings have been listed on either the NYSE or NASDAQ. Most Reg A+ offerings still tend to be listed on competing marketplaces known as “venture exchanges.”

NASAA (North American Securities Administrators Association) had this to say on the topic: “[T]he question becomes, what is the additive value of venture exchanges, which are by definition more opaque, less efficient, more volatile, and more illiquid that U.S. Public markets, which continue to be the envy of the world?” The danger is that this lack of secondary market could enrage unsophisticated investors who are unable to unload their position and subsequently take a big loss.

Internal Considerations For The Partner Group

      Accounting Firm Coverage: The general answer is that your broker should be able to readily point out where in your professional liability policy you are either allowed, or outright forbidden, to provide reviews or audits of publicly traded clients. The long answer is that you should ensure that the services rendered are covered under your definition of “professional services,” and that you do not have an exclusion for publicly traded clients in the exclusions section of your policy. Regardless of your opinion on policy language, always have clearance from your insurer in writing, and consult a legal professional familiar with this area.

      RIA or broker-dealer coverage: If you have an affiliated RIA or broker-dealer component to your practice, you may consider offering Reg A+ securities. However, oversight and guidance from the SEC and FINRA to professionals in this area is particularly sparse and still evolving. Within most RIA and Broker-Dealer professional liability policies, you will likely find an exclusion of coverage for “The purchase, sale, servicing, or recommendation to purchase, sell, or hold … unregistered securities, and private placements.”

Both Tier I and Tier II of Reg A+ require the filing and acceptance of a form 1-A with the SEC, as well as review and acceptance by FINRA prior to the offering of any securities by an RIA or broker-dealer. Thus, Reg A+ offerings can be defined as a “registered security.”

Furthermore, these securities are being listed on “venture exchanges” such as the OTCQB and

TSXV for secondary trading. Ergo, they may not necessarily be considered private placements.

In questioning whether coverage would be afforded under a market standard RIA policy, we posed the question to the executive team of a market leader in insuring RIAs. While they confirmed that offering Reg A+ securities would likely be covered in many instances, they did question why an RIA with a fiduciary standard wouldn’t simply skip the hassle and recommend a more stable and traditional investment.

In turn, the authors consulted a few sizeable RIAs, each with well over half a billion in assets under management (AUM), on the topic of Reg A+ offerings. None had yet taken a Reg A+ offering seriously, and most considered them a “bad idea.”

If you are considering these types of assets with your firm, it is best to speak directly with your broker, underwriter, and competent legal professional who is knowledgeable in this area. Policies differ greatly across the market, and there is no promise or assurance that your policies will cover these activities.

Know that any work provided to publicly traded clients will result in increased scrutiny from your professional liability insurer and may result in a higher yearly insurance premium. The total difference in premium could range from painful to negligible and depends on a host of factors.

If you do not have coverage to render these services to publicly traded clients, it is possible that your insurer may offer a “carve back” for coverage in this area. These carve backs nullify a particular exclusion, with certain conditions, but can often come with decreased limits and very specific wording. If you find yourself in this situation, you will need to pay very particular attention to both the wording and the limits available, or you may find yourself paying more for the same declination of coverage. It is best to receive a specimen carve back beforehand and discuss it with your broker and competent legal professional.

Determine if you have adequate limits to support a class action lawsuit and/or multiple investor suits. As we’ve mentioned previously, we don’t yet have any data to support the cost of a claim arising specifically from Reg A+ work. The best we can offer at this point are SEC class action claims. Also know that the cost of defense for such a case can easily reach into the millions. Ensure that your firm accounts for this potentially large additional cost.

Regardless of your choice to provide services for the purposes of Reg A+ offerings, consider working with your insurer to modify your engagement letters. Typically, you would need to consent to the use of your reports and corresponding financial statements prior to their use in any filing. However, you may elect to specify the intended users of the financials in the engagement letter that they must first receive prior written consent before providing copies to any other user. Why would you take of the administrative burden of considering a change to your engagement letter? The difference in the average cost between a standard audit claim, and an SEC class action suit is about 20X.

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Joseph E. Brunsman is the Vice-President of Chesapeake Professional Liability Brokers, Inc., and is currently pursuing a Master of Science in Law, specialty in Cybersecurity Law.

Daniel W. Hudson is the president, of Chesapeake Professional Liability Brokers, Inc., Annapolis, Md.,