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Case number 15, number 1149 at L. Monica J. Lyndon, Montana State Auditor, ex officio, Montana Commissioner of Securities and Insurance Petitioner versus Securities and Exchange Commission.

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Mr. Tunley for the petitioner, Mr. Berger for the respondent.

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Mr. Turner.

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Good morning, Judge Ginsburg.

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May I please report?

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The rule before us today defies the clear direction of Congress that preemption under the qualified purchaser statutes may only occur when the Commission actually imposes qualifications on purchasers.

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There must be meaningful qualifications that identify those investors who do not require the protection of state law.

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The Commission has imposed no such qualifications here.

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Under its rule, preemption occurs whenever literally any person is offered a purchase of securities under a Tier 2 offering of Regulation A. Is there anything anywhere else that limits the qualifications of the offeres in a Tier 2 sale?

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No, Your Honor, nowhere else.

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This rule violates the plain meaning of the Securities Act.

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It exceeds the authority delegated to the commission by Congress, and it strips from millions of vulnerable investors protections that the states have provided for 100 years.

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So the SEC effectively – in effect said everyone's qualified because there's no need for special protections here.

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That's what the rule says.

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Any person is a qualified purchaser.

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That's the rule.

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It effectively reads the qualified purchaser requirement out of the statute by saying it's everybody.

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I'm not sure why it reads it out as opposed to addressing it and say, all right, in this context, we think everyone's qualified.

[00:02:49] Speaker 01:
Well, any is not a qualification on purchaser.

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The term qualified purchaser has a clear meaning both under the plain language, under the structure of Section 18.

[00:02:59] Speaker 04:
Well, it has a clear meaning that's been delegated to the SEC to determine in each case.

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It varies from one class of issuance to another.

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The commission certainly has discretion to tailor the definition of qualified purchaser to different categories of securities.

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But the power to tailor doesn't mean it can disregard the requirement altogether.

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And does this term qualify?

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I certainly grant you that it doesn't mean that the SEC can disregard the matter and just not address it.

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But it seems here they've addressed it and determined that qualified anyone should be deemed qualified for this issue.

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Yes, well, Your Honor, our position is you can't have a definition of qualified purchaser that doesn't disqualify anyone.

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That's just not what Congress intended.

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This is what Congress intended when it passed Section 18B3, which the Jobs Act incorporates.

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Congress said, in all cases, the Commission's definition must be rooted in the belief that qualified purchasers are sophisticated investors capable of protecting themselves in a manner that renders regulation by state authorities unnecessary.

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And this is exactly how the term qualified has been used in other contexts.

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This is the House Commerce Committee when it passed the 96 law.

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But it's not in the law, it's in the committee report.

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It's in the committee report and the Senate committee report said very much the same thing.

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Yes, your honor.

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Um, but when it's legislative history, but it is at best only it is legislative history.

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But we also think that the plain language of the term, the manner in which congress such language, then you don't need legislative history.

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If you're going on legislative history, you're not helping plain language.

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Your Honor, this Court has said when you look at Chevron Step 1, you look at plain language, you look at statutory structure, you look at usage of the term in other contexts, and you can look at legislative history.

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All those factors weigh in our favor here.

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There has to be some qualifications imposed on investors.

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You can't just open it up to everybody.

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And this is why this case is so important.

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When Congress reserves to itself under Section 18 the power to categorically preempt securities altogether, the power given to the Commission is far more narrow.

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It is just to qualified purchasers.

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And if the Commission is allowed to

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If this rule is upheld, then it can be able to preempt any other category of securities at once.

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All we need to do is issue a similar rule saying any person who's offered a purchase of that category of securities is also qualified.

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But they did it here and they didn't do it in any other context because they determined that the risks here were mitigated, particularly by their 10% rule.

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Well, Your Honor, I can address the 10% rule separately, but with respect to the 2B analysis, I think the Commission's rule entirely violates Your Honor's holding in the Chamber of Commerce versus the SEC case and Judge Sentel's ruling in the American Equity Investment case.

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there was a very paltry assessment of the impact of this rule on investor protections.

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They essentially said, yes, this rule is going to harm investors by taking away state securities review.

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And they said many other parts of the rule could mitigate that impact.

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That is the extent of their economic analysis.

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Two paragraphs in the rule, it does not meet the standards that your honors have set forth in other cases involving the SEC.

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But with respect to the 10% investment limitation,

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That does not impose qualifications on purchasers.

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Quite the opposite.

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It applies only to those group of investors who do not meet the standard for accredited investors under Rule 501A.

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In other words, that subset of investors who, by the SEC's own analysis, aren't able to protect themselves and require the protection of securities law, the investment protection of securities law.

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The investment notation that's applied here says they can invest too, but we're only going to let them lose 10% of their life savings on each particular offering.

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That's the opposite of a qualification on purchasers.

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A rule limiting the amount of losses that a vulnerable and unsophisticated investor can lose on a particular offering is not a qualification on who may invest in the first place.

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And I think Congress was very clear when it passed this.

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Congress could have when it passed Title IV of the Jobs Act.

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It could have categorically preempted all regulations and securities.

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That's what it did under Title III for so-called crowdfunding securities.

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But instead, when Congress looked at the high-risk, generally illiquid securities that are offered under Regulation A, it said, no, we're going to take a different approach here.

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We're going to allow preemption only under two narrow circumstances.

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One, when regulation of these securities are sold on a national exchange, and two, when they're sold to qualified purchasers, consistent with Section 18B3 and the public interest in the protection of investors.

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So I think it was a very deliberate choice made by Congress here not to allow this kind of broad preemption that the Commission put into effect here.

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And I just would say that

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The idea that because the commission has discretion, the commission argues that, well, it has discretion to adapt its definition to different categories of securities.

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And that's absolutely true.

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It can look at the particular risk profile or complexity of security and adjust a definition of qualified purchaser to match that.

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But this court dealt with a very similar argument by the commission in the 2007 case, Financial Planning Association versus the SEC.

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where the commission pointed to a provision that allowed to make exemptions under the Investment Advisors Act.

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And this commission rejected the commission's rule on that case under Chevron step one, and it said, quoting Brown v. Gardner from the Supreme Court, ambiguity is a creature not of definitional possibilities, but of statutory context.

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Here the statute of context is clear.

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Congress reserves the power to categorically preempt state law for categories of securities.

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The Commission's authority is limited to qualified purchasers, and that has the meaning that the term qualified has on the Investment Advisers Act,

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under the Investment Company Act, under other broker-dealing exemptions that the SEC applies, it's always meant that there has to be some degree of wealth sophistication or risk-bearing ability that identifies those investors as people who do not need the protections of state law.

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And I just, on top of our Chevron Step 1 argument, I just want to direct, remind the court... The protections of state law, apart from pre-approval, are still in place, correct?

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Well, Your Honor, the states provide a set of protections.

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They provide registration qualification requirements, they provide regulation of sellers, participants in the marketplace, and they have enforcement authority.

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Enforcement authority is left in place, but the state system relies on the entire set of powers.

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So this really is a dramatic change to how the states go about protecting people in their states and in neighboring states.

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And, of course, state regulators really have unique knowledge about local markets, about... Which the SEC acknowledged with respect to fraud and enforcement.

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That's right.

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It did.

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It did.

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It did acknowledge that they have the local knowledge of marketplace.

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It didn't acknowledge the other unique benefits of state review.

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I mean, it's important to acknowledge that state mayor review is not just

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simple up or down proof reject process.

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It's a process where regulators take a look at the offering.

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They improve the terms of the offering.

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They improve terms of the disclosure.

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They may require the company to implement a stronger conflict of interest policy.

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They may upgrade the risk disclosure.

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They may remove unsubstantiated claims of profitability or investment returns.

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These are very important protections that are needed by unsophisticated investors.

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And the commission's role just takes them out entirely for this class of categories, this class of securities.

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So we think that this rule harms retail investors.

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It disrupts this long-standing system, the balance of power in the dual federal state system of regulating securities.

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The states have been involved in regulating securities far longer than the federal government.

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And it exceeds the authority that Congress gave to the Commission, both in the 1996 Act and in the 2012 Jobs Act.

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And for those reasons, we think that this Court should vacate the rule and direct the Commission to develop a new rule that complies with the intent of Congress.

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May it please the Court, Jeff Berger for the Securities and Exchange Commission?

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I do want to bring this back to the context of the Jobs Act, which was really only mentioned a few times.

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The importance of the Jobs Act is crucial here.

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Congress sought to revitalize Regulation A, which had fallen into disuse in part because of the cost of complying with state registration and qualification laws.

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In implementing the mandate under the Jobs Act to the Commission, the Commission exercised this express authority under Section 18 to define the term qualified purchaser so as to preempt those exact state laws for Tier 2 offerings and only for Tier 2 offerings.

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This removed a main impediment to the use of reggae while still protecting investors by, among other things, and there's a suite of protections requiring that an investor either be accredited or be subject to purchase limitations based on net worth or income.

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And I do think it is crucial to go to the actual provision that is the delegation of authority here, which is section 18B4D, sorry for all the letters.

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Where do we find it?

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What's that?

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I believe it's in the back of the petitioner's brief.

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And it was 18 what?

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18B4D.

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That basically establishes a new category of covered security.

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And for preemptive purposes under Section 18, covered security is the term that initiates the preemption.

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And it says a security is a covered security with respect to a transaction that is exempt from registration under this title pursuant to a rule of regulation adopted pursuant to Section 3B2.

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And such security is, and I'm going to skip to Romanette 2,

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offered or sold to a qualified purchaser as defined by the Commission pursuant to paragraph 3 with respect to that purchase or sale.

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That is Congress's clear intent to delegate definitional authority to the Commission.

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Wouldn't it seem that when Congress delegates the ability to define the term qualified purchaser,

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Wouldn't we normally expect what the commission produces to give something about the qualifications of the purchaser rather than simply say in what kind of exchange they're buying that is a tier two?

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Well, I think, too, in response to that question, one is Congress did tie the definition to, with respect to the purchaser sale of this particular class of securities.

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That's one in terms of Congress.

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That didn't answer my question.

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And in terms of what the commission did, it does reflect the characteristics of the purchaser.

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What characteristic of the purchaser is reflected in that definition?

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Net worth or revenue.

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The greater 10% determines how much you.

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Where do we find that in the definition?

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That would be in Rule 256, sets up the definition, which then basically cross-references Rule 251, which sets limitations on sales.

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You either have to be the accredited investor... In order to... Which means you can buy however much you want, however many reggae securities as you want.

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If you are a non-accredited investor, and the accredited investor definition is in turn borrowed from another rule... So what you're saying is this language about Tier 2 essentially incorporates that by reference.

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That's correct, and I think the Commission could have listed all... So when I asked Council, opposing Council, the question, if there were somewhere else that had some limitations on this Tier 2 purchaser, and you told me there were not, then he was incorrect.

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I disagree with him.

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There are limitations.

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I think the Commission could have listed all those limitations in 256 again, instead of providing... But the effect of setting Tier 2 as the level of purchaser offer effectively

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requires compliance with those qualifications by the buyer.

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That's absolutely correct.

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Thank you.

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Yes.

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And it is a tie to the net worth of the revenue in the sense of if you're a non-accredited purchaser you can only purchase up to a certain amount.

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You got my question answered.

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And I do want to mention that Reg A has always, until this rule, has always been available to everyone.

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at any amount.

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So what the commission in defining qualified purchaser, I understand petitioner's argument to suggest that we're sort of abandoning investor protection, but really what it's doing is doing multiple things.

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It's removing a layer of state review and a substantive merit review process, but in its place it's putting in other protections for investors, which include the purchase limitation I just mentioned.

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But there's other things as well.

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It helped a lot if the commission had simply put in the definition of qualified purchaser those requirements that you just tell me are dragged in through tier two.

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I think the commission, I mean, yes, if the commission had repeated it, it probably would have clarified things even more.

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No, it would have clarified things.

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I wouldn't have had to ask you that question.

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That's true, Your Honor.

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What I was going to say is the Commission was very, very clear in its release that that's exactly what it was doing.

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It repeated over and over that the reason it was comfortable with preempting state laws because of all the other protections afforded to investors here, which include not just the purchase limitation, but also crucial information flows in the terms of a requirement that audited financials be provided with the offering circular.

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That's only for tier two securities.

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Tier 2 offers are also subject to ongoing reporting obligations, which is crucial not only in terms of protecting investors, but also in terms of revitalizing regulation A. It increases the chance of liquidity, which helps both investors and issuers.

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It increases the chance that a secondary market can develop for these securities.

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It is all part of a plan to effectuate Congress's desire to reinvigorate regulation A, which really had fallen into disuse from 2000

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From 2002 to 2014, there were very few Reg A offerings.

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Congress in adopting the Jobs Act, one thing it did was ask the GAO to produce a report that looked at the effect of state law on Reg A offerings.

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One of the things the GAO found, and it was echoed by many commenters to the commission, was that the role of state law, that substantive merit review process, added costs that dissuaded people from using regulation A. This factored in very heavily to the commission's decision to define qualified purchaser in this way and to divide tier one

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in tier two in two different types of offerings.

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And I think that's important because the states retain their full complement of laws.

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They always retain their anti-fraud authority for both tier one and tier two offerings.

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They are not preempted at all for tier one offerings.

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That remains the same.

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In tier one offerings, because of their size, there's a lower offering limit.

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are more likely to be local in nature, at which point the abilities of the state to do what they do best in terms of doing that merit review function, that is where it's going to have the greatest marginal benefit in terms of investor protection, as opposed to tier two offering, which, because of their size, are likely to be more national in scope, where a consistent federal standard is best able to do the job.

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Did the commission address itself specifically

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to whether this revision or this rule would promote efficiency, competition, and capital formation.

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Yes, I think the Commission did that extensively in its economic analysis and its economic consequences analysis.

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I mean, the entire sort of balance of tier one and tier two and the protections afforded to tier two as well as the preemptive aspect of the qualified purchaser definition was viewed with an eye towards how can this promote capital formation opportunities for small business.

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Where is that?

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Specifically about the terms I just mentioned.

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In terms of the state law or?

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If you know about efficiency competition and capital formation.

[00:20:15] Speaker 02:
Sure.

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I mean, the analysis starts and there's a pretty detailed description of

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the overall consideration of it, starting at JA 236.

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But I also think the consideration of efficiency, competition, and capital formation also repeats itself albeit in more specific ways throughout descriptions of what each individual parts of the rule do.

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So for instance, there's a description of some of these considerations of efficiency, competition, and capital formation as also considered alongside investor protection in relation to the discussion of the relationship with state law.

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That begins at JA-258.

[00:20:55] Speaker 02:
Sorry, I just threw a couple different sites at you.

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Throughout this section of the brief, excuse me, this section of the release, the commission is describing how it can increase capital formation opportunities for small businesses by reducing disincentives to use of regulation A.

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while trying to increase liquidity, while trying to increase the possible universe of people who can buy these things.

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If it's only accredited investors who can buy reggae securities, you are dramatically shrinking the universe of potential buyers, which can affect liquidity, which can affect the availability of a secondary market.

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The commission is constantly considering all of these factors.

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Now, petitioners counsel, my friend suggested that the commission sort of just ignored investor protection or sort of brushed it aside.

[00:21:44] Speaker 02:
I don't agree with that.

[00:21:45] Speaker 02:
The commission considered investor protection alongside the other aspects that Congress mandated the commission consider, efficiency, competition, capital formation.

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And while I don't want to suggest that it balanced it, because balancing almost describes a dichotomy between investor protection and capital formation,

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when in fact in this context they're very interlinked, it considered all that and came up with the rule that it thought would best

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fulfill the goals of the jobs act in terms of revitalizing regulation A while still protecting investors in light of the removal of state protection.

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The commission acknowledged that what it was doing was removing the layer of protection for investors, but it felt that the other requirements for tier two offerings substituted in its place other investor protections that would fill the gap.

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If you guys have any further questions, the rules should be upheld.

[00:22:41] Speaker 02:
on time.

[00:22:45] Speaker 01:
Thank you, Your Honor, and I just can't emphasize this point enough.

[00:22:48] Speaker 01:
Judge Sentel, if this rule said only accredited investors can invest in Tier 2 securities, the preempted category of securities, we would not be here today.

[00:22:57] Speaker 01:
But that's not what it says.

[00:22:58] Speaker 03:
It says everyone can be, accredited investors and people who are... What it says is, it can correct me if I incorrectly paraphrase this, it says that a qualified purchaser is one who is either offered or buys in a Tier 2.

[00:23:12] Speaker 03:
That's right.

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Any person.

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for the definition of qualified purchase.

[00:23:31] Speaker 01:
It's a great question, Your Honor.

[00:23:32] Speaker 01:
It doesn't say that.

[00:23:33] Speaker 03:
The rule says... I know it doesn't say that, but if it's the case that... No, I... Elsewhere in the rules, such a question exists for Tier 2 purchase.

[00:23:42] Speaker 03:
And why isn't that at least by implication and adoption of that criteria?

[00:23:46] Speaker 01:
Yes, and most certainly would satisfy the requirement that said elsewhere in the rule.

[00:23:53] Speaker 01:
We're not arguing about that kind of formal difference.

[00:23:55] Speaker 01:
The point is, elsewhere in the rule, it says you can be a purchaser under Tier 2 if you are a credit investor or if you're not a credit investor.

[00:24:05] Speaker 01:
In other words, everybody gets to invest.

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If you're not a credit investor and meet certain criteria.

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Then you can only invest at the 10% of your income or net worth.

[00:24:13] Speaker 01:
So the investment limitation.

[00:24:15] Speaker 01:
But you can invest if you're not an accredited investor.

[00:24:18] Speaker 01:
And this is the category of people who are vulnerable and unsophisticated.

[00:24:21] Speaker 01:
They are allowed to invest.

[00:24:23] Speaker 03:
It's this different... If they had expressly said in the rule that a qualified investor is somebody who meets the criteria laid out in the regulations concerning Tier 2 transactions, that is to say they couldn't invest more than 10% of their income or they... Would that not be within the

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discretion given to the Commission under the statute for purposes of our Chevron review.

[00:24:51] Speaker 01:
Absolutely.

[00:24:51] Speaker 01:
If Congress had said, told the Commission, listen, come up with the best set of offering terms and conditions.

[00:24:55] Speaker 01:
No, no, no, no.

[00:24:56] Speaker 03:
Congress did what they did.

[00:24:57] Speaker 03:
They did what they did.

[00:25:00] Speaker 03:
And we have a steady regulation that says it's a little more than this one.

[00:25:03] Speaker 03:
Instead of saying offered our bought in a tier two, it said offered our bought in a tier two and meets the criteria required for a tier two and set forth those criteria.

[00:25:14] Speaker 03:
Would that not be within our Chevron definition?

[00:25:19] Speaker 01:
And didn't use the word qualified purchaser?

[00:25:21] Speaker 03:
it's defining qualified purchaser.

[00:25:23] Speaker 01:
If it defined a qualified purchaser and took it out of the meeting that it has under plain language and the other statutory context.

[00:25:28] Speaker 03:
Never mind plain language and all of that.

[00:25:31] Speaker 03:
You've got a statute.

[00:25:33] Speaker 03:
You have a posited regulation that instead of using the words in the present regulation says was offered or bought in a tier 2 and the purchaser meets the criteria necessary to participate in a tier 2.

[00:25:47] Speaker 03:
Why would that not be within their discretion and understanding?

[00:25:50] Speaker 01:
As I understand, I think that would be giving the Commission discretion to come up with this kind of approach.

[00:25:56] Speaker 01:
But, of course, that's not what Congress did.

[00:25:58] Speaker 01:
Congress actually imposed... I don't know what the Commission did.

[00:26:00] Speaker 03:
We know what Congress did.

[00:26:03] Speaker 01:
Just in Title III, Congress actually did impose investment limitations for crowdfunding securities.

[00:26:09] Speaker 01:
It didn't mention investment limitations in Title IV, and it said you have to be a qualified purchaser.

[00:26:15] Speaker 01:
And so I just can't stress enough, the idea that you don't have to satisfy the investment location if you're an accredited investor.

[00:26:24] Speaker 03:
Do you say that opposing counsel misstated anything concerning what he told me about here?

[00:26:31] Speaker 01:
I would respectfully say you cannot say that this is limited to accredited investors.

[00:26:37] Speaker 03:
Don't talk about his conclusion.

[00:26:39] Speaker 03:
Talk about just what he told me.

[00:26:41] Speaker 03:
I disagree with that characterization as I understand it.

[00:26:44] Speaker 03:
What do you say was wrong with what he told me?

[00:26:46] Speaker 01:
My understanding was he said that the commission essentially defines qualified purchaser to mean a credit investor.

[00:26:52] Speaker 03:
Go back to what he told me about what Tier 2 says.

[00:26:57] Speaker 03:
What is required for this being in Tier 2?

[00:27:00] Speaker 03:
Did he tell me anything wrong about that?

[00:27:04] Speaker 01:
Beyond what I just said, Your Honor, I don't recall any of the statements.

[00:27:08] Speaker 01:
But I just have to say that the features provided that the Commission points to – the various features for auditing financial filing requirements and the investment limitation – none of it adds up to a qualification on who may invest in these securities in the first place.

[00:27:25] Speaker 01:
And that is clearly what Congress intended.

[00:27:27] Speaker 01:
And I think to allow – to uphold this rule would give the Commission a green light to disregard other statutory directives with similar clarity.