In Lindeen v. SEC, 825 F.3d 646 (D.C. Cir. 2016), the United States Court of Appeals for the D.C. Circuit denied a consolidated petition for review of a challenge to the principles in Regulation A+ that preempted state law. 

In 2012, Congress passed the Jumpstart Our Business Startups Act (“JOBS Act”), which added section 3(b)(2) to the Securities Act of 1933 (“Securities Act”). Section 3(b)(2) directed the SEC to revamp Regulation A, a historically underutilized set of regulation exemptions to allow small businesses to increase their access to capital. Among other things, the provision provided that state law would be preempted with respect to shares sold to a “qualified purchaser” but left the definition of the term to the Commission. 

The SEC adopted Regulation A-Plus on March 25, 2015.  The Regulation created a new category of offerings up to $50 million and stipulated a number of investor safeguards (“Tier-2 Securities”). Regulation A-Plus also defined qualified-purchaser as “any person” purchasing securities in a Tier 2 offering.  Securities could be purchased either (1) by an “accredited investor”, or (2) by a non-accredited investor who refrains from purchasing securities valued at more than 10 percent of their worth or annual income.

Secretary William F. Gavin of the Massachusetts Securities Division and Commissioner Monica J. Lindeen of the Montana State Auditor Office (collectively, “Petitioners”) alleged that because the SEC declined to adopt a qualified-purchaser definition limited to investors with sufficient wealth, revenue, or financial sophistication to protect their interests without state protection, Regulation A-Plus failed both parts of the test for administrative deference stipulated in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 (1984). The Petitioners further alleged that Regulation A-Plus was arbitrary and capricious because it failed to adequately explain how it protected investors.

Step 1 of Chevron requires a showing of the ambiguity of the statute administered by the agency.   Petitioners argued the SEC’s qualified-purchaser definition, which did not restrict the sale of Tier-2 Securities to wealthy or sophisticated investors, contravened the plain meaning of the Securities Act. Specifically, Petitioners asserted the new qualified-purchaser definition (1) contradicted the exclusionary nature of the plain meaning of the word “qualified”, (2) the definition was not consistent with the public interest and the protection of investors, (3) the regulation renders the word “qualified” superfluous, (4) federal securities law had always linked the term “qualified” with investor wealth and sophistication, and (5) legislative history showed Congress intended for the SEC to limit the qualified-purchaser definition to one of a certain level of wealth or sophistication.

The court disagreed, reasoning when Congress explicitly authorized an agency to define a term, “it ‘necessarily suggests that Congress did not intend the word to be applied in its plain meaning sense.’”  Legislative history demonstrated that Congress had permitted the SEC to vary the definition depending upon the “categories of securities” involved and that Congress explicitly granted the SEC discretion to determine how to best protect the public and investors.

At Step 2 of Chevron, a court must defer to the agency’s interpretation so long as reasonable.  Petitioners asserted that (1) Congress’ preemptive purpose was not “clear and manifest” from the statute, (2) the SEC failed to provide a reasoned explanation for its definition, and (3) the SEC failed to explain why its definition changed from the one it had initially proposed in the rule-making process. The court again disagreed, reasoning that Congress’ decision to exempt “qualified purchasers” from state requirements was clear and manifest, the SEC had in fact provided a sufficient explanation of how its definition would provide a meaningful addition to existing capital formation options of smaller companies while maintaining important investor protections, and the SEC had no obligation to adopt the definition it had proposed at the outset of the rule-making process.

Finally, the court found that the interpretation was not arbitrary and capricious. A rule is arbitrary and capricious if an agency fails to consider factors required by the statute.  Section 2(b) of the Securities Act requires the SEC to to consider whether the action will promote efficiency, competition, and capital formation. 15 USC 77b(b).  The court found the SEC’s analysis of investor protections and mitigating costs on issuers to comply with these statutory obligations. The SEC did not have the data necessary to precisely quantify the risks of preemption for investors and the costs of state law compliance for issuers.

Accordingly, the consolidated petition for review was denied by the court.

The primary materials for this case can be found on the DU Corporate Governance website.