April 25, 1997
By Federal Express and Electronic Mail
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Proposed Changes to Regulation S
File No. S7-8-97
Ladies and Gentlemen:
The Committee on Securities Regulation of the Business Law Section of the Los Angeles County Bar Association appreciates the opportunity to comment on Release Nos. 33-7392, 34-38315 and IS-1056, dated February 20, 1997. The Release relates to proposed changes to Regulation S covering the safe harbor for offshore sales.
The Committee on Securities Regulation is composed of members of the Los Angeles County Bar, a principal part of whose practice is in securities regulation. The Committee includes primarily lawyers in private practice and includes lawyers with experience in corporate law departments and attorneys who have practiced as employees of governmental organizations. A draft of this letter was circulated for comment among our members and the views expressed in this letter are generally consistent with those of the majority of our members who reviewed the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which our members are associated, the Los Angeles Bar Association or its Business Law Section.
We welcome your initiative to try to revise Regulation S to eliminate abusive practices, however, we believe the proposed changes will effectively eliminate the usefulness of Regulation S for small public issues and thus, go beyond what is necessary to eliminate abusive practices.
Please note that this comment is directed to the securities and transactions to which the Commission's proposals relate, and as to which the Commission proposes to relate new holding periods and other standards. Consequently, this comment does not address any issues relating to securities or transactions not addressed in the Commission's proposal.
We believe that the proposed change in the length of the restricted period is substantially longer than is necessary to respond the problems perceived by the Commission. When initially proposed, the Commission suggested a 90-day restricted period to ensure that securities sold under the safe harbor of Regulation S came to rest outside the United States. This period was eventually shortened to 40 days based on comments received by the Commission . We believe the 90-day period originally proposed by the Commission is adequate time for securities to come to rest offshore, provided that the buyer is fully at risk for the securities purchased. Ninety days is more than twice as long as the current 40-day restricted period; given the volatility of securities markets, such a period is certainly adequate to determine that an offering has come to rest offshore.
To the extent that the Commission believes a 90-day restricted period would not be adequate to ensure that issuances under Regulation S come to rest offshore, we also suggest that the Commission consider incorporating from Rule 144(d)(1) the concept that the restricted period does not begin until the full purchase price or other consideration is paid or given by the person acquiring the securities from the issuer or an affiliate. By incorporating this concept, additional comfort that purchasers were at risk for their transactions and, therefore, many of the concerns expressed in the Release and the Interpretive Release (33-7190, IS-821, June 27, 1997) could be avoided. The other concepts under Rule 144(d) for determining when the purchase takes place could also be incorporated into Regulation S, although the special rule in Regulation S, Rule 902(m), addressing the treatment of warrants, should be retained in its present form.
By extending the restricted period to 90 days and incorporating the Rule 144(d) full payment concept into Regulation S, many of the abusive practices cited by the Commission would be avoided. In particular, the issue of the use of promissory notes addressed in the proposal would be cured. An outright prohibition on the use of promissory notes seems overly restrictive and unnecessary.
Finally, we note that the Regulation S proposal addresses the Commission's desire to eliminate the problem of shifting the risk back to the U.S. by foreign purchases engaging in short selling or other derivative transactions in the issuers securities in the United States. We believe this concern may be effectively addressed by tolling the restricted period during any period in which such specific activity is engaged in. This approach was used early on in the Rule 144 context when the holding periods were tolled for any short positions. Therefore, creating short positions or other hedging transactions in the United States during the restricted period should toll the restricted period.
Increased Discounts and Increased Costs
The current proposal does not deal directly with the Interpretive Release's concern over excessive discounts. We agree that other payments to hold the securities offshore during the restrictive period should be prohibited. However, the measurement of discounts is, by its nature, subjective, as the Commission recognized in Note 14 to the Interpretive Release and in Sectionof the Release. Many factors are considered in determining the discount from market for securities not sold into the trading market. Besides the risks related to the issuer, the most important is the length of time in which the securities are tied up. Prior to the recent amendments to Rule 144, discounts for less mature companies engaging in Regulation D or other private placements were around 50% of market prices even when the issuer undertook to immediately file a Form S-3 resale registration statement.
We cannot, or course, predict the scope of discounts with the shortened Rule 144 holding period effective April 29, 1997. However, by so drastically lengthening the restricted period as proposed, the discounts in Regulation S transactions will necessarily substantially increase and will equal those of private placements.
We also note that, in addition to increasing discounts, further additional costs will be incurred because purchasers will regularly require the filing of a registration statement after sale. Filing a registration statement will, of course, substantially increase costs of a Regulation S transaction. Current practice in Regulation S transactions is for the issuer to agree to file a registration statement to cover the sale of the Regulation S securities in the United States only if a change in Regulation S would affect the 40 day restricted period and the ability to resale after the end of the restricted period. If the proposal is adopted, we believe that distributors and purchasers will demand that the issuer file a resale registration statement after the closing of the Regulation S transactions as is the practice in many private placements of public issuers. The cost of this registration statement would not simply address a perceived abuse, it could substantially inhibit Regulation S transactions altogether.
Finally, we note that if the proposals are adopted as presented, only a limited distinction would exist between Regulation S transactions and a Regulation D transaction to accredited investors within the United States. This result is particularly true for Rule 506 transactions following the preemption most state blue sky laws. The costs of completing both transactions and timing would be about the same, but without substantial rationale.
Rule 144 "Restricted Securities"
One of the reasons the Commission cited in the Release for incorporating Regulation S sales into the concept of "restricted securities" under Rule 144(a)(3) is to keep all holding periods for the sales of unregistered securities the same. However, the holding period for intrastate offerings under Rule 147(e) is only nine months. Therefore, the proposal will not make all the holding periods consistent. Further, holding periods for securities issued pursuant to Section 3(a)(10) are not dealt with.
We also believe that by defining Regulation S securities as "restricted securities," the Commission is mixing apples and oranges. All the other definitions of "restricted securities" involves essentially private transactions under Section 4(2) of the Act or various private transactions under Section 3(b) of the Act. The proposed expansion of the definition of "restricted securities" would bring in for the first time true public offerings and severely strain the purpose of Rule 144 as set forth in the Preliminary Notes thereto. Further, Ruletransactions are not so included.
Effect on Future Regulation S Transactions
We believe that if the proposal to incorporate Regulation S transactions into the definition of "restricted securities" is adopted and the holding period is lengthened beyond 90 days, the Commission will effectively eliminate the availability of Regulation S offerings for small public issuers. Many foreign investors are not prepared to invest in the equity securities of small U.S. public issuers unless they have the option of liquidating their investment if a change conditions warrant such an action. Therefore, we expect that many of these investors will simply avoid Regulation S offerings and invest outside the United States. The unavailability of capital will be borne disproportionately by smaller issuers, who have fewer options for investment capital. To that end, the Regulation S proposal is likely to harm small and growing businesses, which fuel a significant percentage of growth in the United States. Further, investors in other countries have a greater expectation regarding their privacy and public disclosure and the need to file Rule 144 Forms on sale may also chill the market the foreign investors. The lack of U.S. style disclosure in other countries is recognized by the Commission in the special registration statements forms and Securities Exchange Act of 1934 forms designed for non-U.S. issuers. We believe the Commission should continue to recognize this fact.
Proposals for Legending and Agreements With Purchaser
The proposed requirements for legending the equity securities and requiring agreements from purchasers would effectively preclude a U.S. public company from offering its equity securities offshore under Regulation S, particularly through the facilities of a foreign securities exchange. It is impractical in a true widely distributed public offering offshore to try to obtain written agreements from the purchasers, particularly on a foreign securities exchange. Further, the agreement with the initial purchaser will not bind an subsequent purchaser, making such a requirement of limited, if any, value.
Secondly, many foreign securities exchanges will not allow trading of securities with legends restricting transfer. Rather than inhibit listing on foreign exchanges, it would seem that the Commission in Regulation S offerings should encourage issuers to list their securities on a foreign securities exchange since such listings will make it less likely that the shares will be sold into the United States market.
Finally, for United States issuers with already existing offshore securities markets, the legending and written agreement requirements may make it impractical to conduct further offshore offerings.
Section III.D of the Release discusses the need to conduct a traditional "underwriter" analysis under Section 2(11) for resales under Sectionafter the end of the restricted period. While not specifically stated in Regulation S, the restricted period can have but one purpose -- to establish a bright line test as to when the offering comes to rest offshore. Imposing an "underwriter" analysis would force an issuer and distributor have to provide the extensive warnings about the restricted period required by Regulation S, and then confuse potential purchasers by advising them that it is unclear as to when the shares can be resold into the United States. Footnote 110 to the release adopting Regulation S (Release No. 33-6863, April 24, 1990) states specifically that after the restricted period the shares would be unrestricted. The position taken by the Commission in the Release and the Interpretive Release suggests an attempt to rewrite Regulation S, and the meaning of the restricted period, retroactively, after reliance by investors on these provisions.
The position taken in the Release also ignores a practical issue: for a cash sale offshore to persons unaffiliated with the issuer, how can an issuer to conduct a traditional underwriter analysis that the purchaser took without the intent to resale into the United States, particularly in a true public offering offshore? Obviously, the purchaser intends to eventually resell the shares in the United States if the principal, or only, market is here. The sole purpose of the restricted period is to define when the offering comes to rest offshore and thus when the purchaser or his purchaser can then resell into the U.S. market.
This can be compared to affiliates of an issuer who acquire shares in Regulation S transactions. Such purchasers should be able to sell under Rule 144 after the end of the restricted period, although other concerns such as Sections 10b-5 and Section 16 of the Securities Exchange Act of 1934 may not make such option possible.
We recognize that the Commission has a valid interest in avoiding truly abusive practices, particularly those cited in the Interpretive Release with regard to parking the securities offshore with the eventual proceeds going to the issuer. However, these transaction can be challenged by using Preliminary Note 2 as a scheme to evade the registration provisions. Further, the Commission can always deal with perceived future abusive practices by interpretive releases or future rule making.
As a final comment, the Release did not indicate what effect the adoption of the changes in the Release would have on already completed Regulation S transactions upon its effectiveness. Therefore, it would seem, that if the proposals were adopted, already outstanding Regulation S securities would become restricted securities and have to be sold under Rule 144. However, this retroactive approach is impractical. In the first place, a retroactive approach may force foreign buyers to sell their remaining Regulation S shares into the market place in mass thereby severely depressing the market prices for an issuer with substantial Regulation S shares outstanding. Secondly, since for public issuers the shares sold in Regulation S transactions are unlegended, particularly if the restricted period has lapsed, there would be no way to enforce the new requirements because under the Uniform Commercial Code the issuers and their transfer agents would be liable for the failure to transfer an unlegended stock certificate, particularly in the hands of a bonathird party purchaser for value. Thirdly, to the extent the unlegended shares have been placed in street name, there is no way the issuer could enforce any transfer restrictions.
We would like to express our appreciation for the opportunity to express these comments. We are available to discuss them further if you so desire.
Very truly yours,
ROBERT E. BRAUN, P.C., of
Jeffer, Mangels, Butler & Marmaro LLP
cc: The Hon. Arthur Levitt, Chairman
The Hon. Steven M.H. Wallman, Commissioner
The Hon. Isaac C. Hunt, Jr., Commissioner
The Hon. Norman S. Johnson, Commissioner
Brian J. Lane, Director, Division of Corporation Finance
Ann D. Wallace, Senior Counsel to Director of Corporation Finance
Los Angeles County Bar Association, Business and Corporations Law Section