May 30, 1997
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Offshore Offers and Sales (File No. S7-8-97)
Dear Mr. Katz:
This letter is in response to the Commission's request for comment on its proposed amendments to Regulation S under the Securities Act of 1933 (the "Act") set forth in Release No. 33-7392 (February 20, 1997) (the "Release").
I urge the Commission not to adopt the proposed amendments, primarily for the following reasons:
- They have not been shown to be necessary to prevent the abuses cited by the Commission.
- They would significantly impair the ability of U.S. issuers to raise capital in the offshore markets.
- The application of the proposed amendments to foreign issuers with a "principal market" in the United States is unworkable and likely to undermine the international comity that Regulation S and other Commission initiatives were designed to foster.
1. The amendments have not been shown to be necessary . As noted in the Release, the Commission has already taken enforcement action against persons who have sought to evade the
registration requirements of the Act through purported Regulation S offerings that were in effect U.S. distributions of securities. Indeed, some of these persons have also been the subject of criminal proceedings as well as private civil proceedings.
The extent of abuse in this area, however, remains unclear. Apart from the proceedings cited in the Release, the evidence is largely anecdotal. Specifically, the Commission has not disclosed the basis for its belief stated in the Release that "abusive practices ... may have defrauded investors of millions of dollars". Nor has the Commission provided any basis for its statement in the Release that the proposed amendments would not result in "a major increase in costs" for issuers or that such an increase would be offset by "enhancing investors' confidence in the integrity of the securities markets".
It is difficult to quantify the amendments' effect on issuers' costs, although these are likely (as discussed below) to be real and not offset in any meaningful way by speculative notions of "investor confidence".
What is clear, however, is that there is a lower-cost, disclosure-based way of discouraging abuses that the Commission itself installed only a few months ago and that the Commission now inexplicably proposes to abandon. I refer, of course, to the reporting requirement adopted in Release No. 34-37801 (October 10, 1996). The reporting requirement was based on the premise that issuers would be reluctant to admit publicly that they were engaging in offshore equity sales at substantial discounts. It was also intended as a means for the Commission to identify potentially abusive transactions for possible enforcement action.
The Commission has simply not allowed sufficient time to determine whether the reporting requirement will or will not have the effects that the Commission anticipated in October 1996. The cost to issuers of reporting these transactions is insignificant, and a reporting requirement is much more consistent with the disclosure-based philosophy of the securities laws than the complex and intrusive set of rules that the Commission proposes as a substitute.
One would hope that the Commission would adopt the proposed amendments only if there were compelling evidence that there was no other way to prevent abuses. The Commission's cost-benefit analysis set forth in the Release is seriously deficient on this count, both in failing to provide data about the incidence of abuse and by failing to explain why the reporting requirement has not been given a chance to work.
I note that, as to the application of the proposed amendments to foreign issuers with a primary market in the United States, the Release is somewhat disingenuous when it states that abuses by foreign issuers are "not as evident" -- in fact, there is no evidence of such abuses by foreign issuers.
2. The proposed amendments will significantly impair the ability of U.S. issuers to raise capital in the offshore markets . As the Commission is well aware, U.S. issuers require access to international securities markets in order to raise capital on competitive terms. Even as to equity securities, the Release notes that unregistered offshore offerings are an important source of capital for many U.S. issuers.
While the Commission's enforcement burden would undoubtedly be eased by a requirement that U.S. issuers register all of their public securities offerings, it is too late in the day to pretend that the Commission could bring about this result by rulemaking. Release 33-4708 and subsequent Commission statements make it manifestly clear that the Act does not apply to offshore distributions. This is not to say, of course, that the Act does not apply to persons who function in effect as "underwriters" in distributing securities in the United States.
Assuming that the Commission wishes to preserve the offshore markets as a source of equity capital for U.S. issuers, it must recognize that the proposed amendments would significantly undermine this goal. Offshore investors have many investment opportunities available to them. Why should they choose to buy "restricted" securities with a "holding period" of one or two years? 1 Why should they choose to buy securities where they are required to make certifications, even where the content of the certification does not present a problem? Why should they have to agree to resell the securities only in a certain manner? Why should they choose to accept certificates bearing legends that purport to restrict resales and hedging activity?
The proposed amendments can only increase the discount at which U.S. issuers are able to sell equity securities to offshore investors. This is hardly in the interest of U.S. issuers or their securityholders.
3. The application of the proposed amendments to foreign issuers with a "principal market" in the United States is unworkable and likely to undermine the international comity that Regulation S was designed to foster. Even if the foregoing picture were insufficient to persuade the Commission of the unsoundness of the proposed amendments, this must surely become clear when one imagines the effect of the proposed amendments on foreign issuers that have their "principal market" in the United States. Like any issuer, a foreign issuer has little control over where its securities are traded. In addition, a foreign issuer may not have reliable information on the volume of trading in markets outside the United States. 2 (At least, the definition of "foreign private issuer" in Rule 405 permits some degree of predictability.)
I ask the Commission to imagine, however, the consequences of informing a foreign issuer that its sales of equity securities in its own securities markets may be subject to restrictions imposed by U.S. law. Moreover, these restrictions would not be theoretical since they would tend to increase the foreign issuer's cost of raising capital in its own market.
Under the circumstances, the sensible foreign issuer would -- after urging its government to lodge a diplomatic protest with the U.S. Department of State -- avoid the U.S. trading markets under any and all circumstances. It would not sponsor a Level 1 ADR program; it would not comply with Rule 12g3-2(b); it would exclude U.S. investors from participation in rights offering and exchange offers; it would not undertake a Rule 144A equity placement in the United States.
In short, all of the "stepping stones" that the Commission has provided to encourage foreign issuers to enter the U.S. markets would be perceived as booby traps.
There is an alternative, of course, for U.S. and foreign issuers. They can ignore Regulation S completely. After all, their bona fide offshore purchasers will still be able to resell to U.S. dealers in reliance on Section 4(1), and these dealers will still be able to resell to U.S. investors in reliance on Section 4(3)(A) after the expiration of 40 days following a bona fide public offering -- whether or not the offering takes place outside the United States. This means, of course, that the enforcement problems the Commission may be seeking to avoid by the proposed amendments might quickly return as it became necessary to distinguish bona fide transactions from "abusive" transactions.
One might also expect, of course, that U.S. and foreign issuers would strenuously avoid any use of "jurisdictional means" in their offshore offerings. This would probably mean dispensing with the participation of those U.S. underwriters, depositories and law firms that best understand the difference between bona fide and abusive transactions. Again, we do not see how this would be in the interests of the U.S. securities markets or the Commission's enforcement efforts.
I urge the Commission to postpone action on the proposed amendments until there is additional data on the incidence of abuse in this area and as to the efficacy of the reporting requirement imposed in Release No. 34-37801 in mitigating such abuse.
Very truly yours,
|1||I note that the Commission achieves nothing by amending Rule 144 to include suspect equity securities in the definition of "restricted securities". Rule 144 is only a safe harbor for persons effecting resales, and it imposes no new restrictions. As observed in note 52 to the Release, the designation simply puts purchasers on notice that they are not supposed to act as underwriters when they resell those securities. This would be the case with or without the proposed amendments.|
|2||I note in passing that the Release is silent on whether the volume of trading should be determined on the basis of share volume or dollar volume. (If dollar volume, would this be based on local currency or U.S. dollars? On a fixed or floating rate basis during the relevant one-year period?) Also, would dealer trades in the over-the-counter market be counted once or twice? There are many other ambiguities on this point.|