With so many community banks being acquired as part of a general consolidation in the industry, many institutions must sell their own equity securities in order to scale operations. A key decision banks must make when considering a sale of securities is whether to register the offering under the securities laws — commonly referred to as “going public” — or to rely upon one or more exemptions from the registration requirements.
The most common exemption from registration under the United States’ securities laws is Rule 506(b) of Regulation D under the Securities Act of 1933, as amended (the “Securities Act”). However, Rule 506(b) limits the number of “unaccredited” investors (broadly, anyone with less than $1 million in net worth, exclusive of residence, or $200,000 in annual income) in an offering to 35 such investors. Further, securities issued in Rule 506(b) offering will be restricted and cannot be transferred for up to a year, adding a layer of illiquidity beyond the usual challenges that community banks face as a result of industry-wide low private market trading volume.
Traditionally, despite the challenges under Rule 506(b), many community banks did not consider going public due the cost and time involved with filing a Form S-1 registration statement and application for a national exchange such as the Nasdaq Stock Market or the New York Stock Exchange, not to mention the expense related with on-going reporting to the Securities and Exchange Commission (the “SEC”) necessary to keep securities eligible for listing on the national exchange.
Since the passage of the JOBS Act in 2012, however, times have changed. Privately held banks considering an offering of their securities should be aware of two recent developments that may alter the analysis as to whether to go public:
The enactment of amendments to Regulation A under the Securities Act, and
OTC Markets’ development of an exchange for bank stocks.
Regulation A (or Reg A+), adopted as part of the amendments made by the JOBS Act of 2012, is intended to be a more economical way for smaller entities, such as community banks, to go public. Under Reg A+, banks and bank holding companies can issue up to $20 million in unrestricted securities to an unlimited number of individuals across the country in what is known as a Tier 1 offering. This is an especially powerful tool for banks that are exempt from certain aspects of state level, or blue sky registration, as a result of Section 3(a)(2) of the Securities Act. Reg A+ also allows Tier 2 offerings of up to $50 million, yet those come with more reporting and compliance obligations.
Like a traditional public offering, securities in a Reg. A+ offering can be offered and sold to the general public, and a Reg A+ offering can lead to an immediate listing on a securities exchange to provide liquidity for future transactions. As discussed below, a Reg A+ offering can also be an excellent catalyst to be quoted on over the counter marketplaces as well.
The OTC Markets Group Inc. operates three marketplaces on which all banks may apply for listing. Most banks now apply for listing on the OTCQX, as it has a specialized product aimed at bank stocks called OTCQX Banks.
Perhaps the largest advantage of listing on the OTCQX is that separate financial reports do not need to be filed with the SEC, as the reports that banks routinely file with their bank regulator (such as Call Reports) are generally sufficient to satisfy the OTCQX’s requirements. However, Reg A+ issuers do have to file reports with the SEC while the Reg A+ offering is on-going.
Weighing the options
The decision to go public should always be carefully analyzed and may not be the best alternative in many cases, especially if one or more exemptions from registration is readily available.
For example, successfully completing a Reg A+ offering or listing on the OTCQX does not guarantee a liquid trading market for a bank’s stock, so banks still need to evaluate whether sporadic trading that may take place on the exchange is an advantage worth pursuing.
However, the recent developments in the OTCQX and Reg A+ may make going public more cost-effective than before and may be a viable alternative for some banks that would otherwise not consider this option for raising capital.
Marc Adesso is an attorney with Waller in Nashville. Issuers, investment banks and high net worth individuals in a range of industries rely on Marc’s unique insight with regard to capital market matters.