Your Offering Statement has been qualified by the SEC. Now something changes. Do you have to file something with the SEC? If so, what and how?
Changes Reported on Form 1-U
Some changes must be reported using Form 1-U:
- If the issuer has entered into or terminated a material definitive agreement that has resulted in or would reasonably be expected to result in a fundamental change to the nature of its business or plan of operation.
- The bankruptcy of the issuer or its parent company.
- A material modification of either (i) the securities that were issued under Regulation A, or (ii) the documents (g., a Certificate of Incorporation) defining the rights of the securities that were issued under Regulation A.
- A change in the issuer’s auditing firm.
- A determination that any previous financial statements cannot be relied on.
- A change in control of the issuer.
- The departure or termination of the issuer’s principal executive officer, principal financial officer, or principal accounting officer, or a person performing any of those functions even if he or she doesn’t have a title.
- The sale of securities in an unregistered offering (g., Rule 506(c)).
Form 1-U may be used, at the issuer’s discretion, to disclose any other events or information that the issuer deems of importance to the holders of its securities.
NOTE: If an event has already been reported on an annual or semi-annual report, the same event does not have to be reported again on Form 1-U.
NOTE: A report on Form 1-U must be filed even if the Regulation A offering has ended.
After the offering is qualified by the SEC, the issuer must file an amendment of its Offering Statement “to reflect any facts or events arising after the qualification date. . . .which, individually or in the aggregate, represent a fundamental change in the information set forth in the offering statement.”
Examples of fundamental changes:
- A change in the offering price of the security.
- A change in the focus of the issuer’s business, g., we were going to focus on cryptocurrencies, but now we’re pivoting to blockchain-based financial services.
- The bankruptcy of the issuer.
- A change in the type of security offered, g., from preferred stock to common stock or vice versa.
An amendment of an Offering Statement must be approved by the SEC before it becomes effective, which means waiting.
Even more important, depending on the nature of the change, the issuer might be required to stop selling securities or even stop offering securities (i.e., shut down its website and all marketing activities) while the amendment is pending.
After the offering is qualified by the SEC, the issuer must file a supplement of its Offering Circular to reflect “information. . . .that constitutes a substantive change from or addition to the information set forth” in the original offering circular.
Examples of substantive changes or additions:
- A new Chief Marketing Officer joined the management team.
- The issuer’s patent application, disclosed in the original Offering Circular, was approved.
- The issuer moved its principal office.
Unlike amendments, supplements do not require SEC approval and do not require that that the issuer stop selling or issuing securities. Instead, the supplement must be filed with the SEC within five days after it is first used.
Real Estate Supplements
While its offering is live, an issuer in the real estate business — a REIT, for example — must file a supplement “[w]here a reasonable probability that a property will be acquired arises.” Not when the property is purchased, but when there is a “reasonably probability” that it will be purchased.
The SEC doesn’t specify what information to include in these supplements, except to disclose “all compensation and fees received by the General Partner(s) and its affiliates in connection with any such acquisition.” Including a statement of any significant risks associated with the property is a good idea, too.
Having filed a separate supplement for each property, the real estate issuer must then file an amendment at least once every quarter that consolidates the supplements and includes financial statements for the properties. Notwithstanding the general rule for amendments, however, the issuer doesn’t have to stop offering or selling securities pending SEC approval.
Supplement vs. Amendment
An amendment is required for “fundamental changes,” while only a supplement is required for “substantive changes.” Where to draw the line?
There’s a lot at stake. If an issuer uses a supplement where it should have used an amendment, it will be using an Offering Statement that has not been qualified by the SEC. Meaning, the whole offering will be illegal.
The SEC won’t say whether it believes a given change requires a supplement or an amendment, leaving the decision to the issuer and its lawyer. The SEC will, however, allow an issuer to file an amendment even for non-fundament changes, i.e., where a supplement would have done the trick. Filing an amendment takes a little longer, costs a little more, but eliminates the risk of guessing wrong.
Often, however, an issuer wants to make a change but doesn’t want to go through the amendment process. In those cases, the rule of thumb should be as follows:
Would an investor of ordinary prudence want to re-think his investment decision based on the new information?
If the answer to that question is Yes, the new information should be provided via amendment. If the answer is No, it can be provided supplement.
For example, an investor who liked the cryptocurrency space might not be interested in the financial services space, while the addition of a new CMO might be interesting and useful, but unlikely to affect the investment decision.
Contrary to popular belief, the main risk of this or any other violation of the securities laws is not that the SEC will bring your offering to a screeching halt or fine you. Those things are possible, but the SEC has more important things on its plate. The main risk is that an investor will lose money and hire a clever lawyer, who will then seize on your mistake (or your alleged mistake) as grounds to get the investor’s money back.
Supplement vs. Form 1-U
If a change falls within any of the specified categories of Form 1-U, then it should be reported on Form 1-U rather than via supplement.
If the offering has ended, then supplements are no longer relevant and changes should be reported on Form 1-U.
If the offering is still live and the change does not fall within any of the specified categories of Form 1-U, then it can be reported on either Form 1-U or via supplement, take your pick. However, supplements may not be accompanied by exhibits. So if you need to change or add an exhibit (e.g., you’ve modified your Subscription Agreement or entered into a material contract that doesn’t constitute a fundamental change), you should use form 1-U.
Questions? Let me know.