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SECURITIES AND EXCHANGE COMMISSION
17 CFR PART 231
RELEASE NO. 33-7190 INTERNATIONAL SERIES NO. 821 FILE NO. S7-20-
95 PROBLEMATIC PRACTICES UNDER REGULATION S
AGENCY: Securities and Exchange Commission
ACTION: Interpretive Release; Request for Comments
SUMMARY: The Commission is publishing its views concerning
problematic practices under Regulation S and is requesting
comment as to whether Regulation S should be amended to limit its
vulnerability to abuse. The Commission will study the comments
received in response to this release and will determine whether
rulemaking or other action is necessary or appropriate.
DATES: This interpretation is effective [upon publication in the
Federal Register]. Comments should be received on or before
September 8, 1995.
ADDRESSES: Comment letters should refer to File number S7-20-95
and should be submitted in triplicate to Jonathan G. Katz,
Secretary, U.S. Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549. The Commission will make
all comments available for public inspection and copying in its
Public Reference Room at the same address.
FOR FURTHER INFORMATION CONTACT: Paul Dudek or Annemarie
Tierney, (202) 942-2990, Office of International Corporate
Finance, Division of Corporation Finance, U.S. Securities and
Exchange Commission, Washington, D.C. 20549.
SUPPLEMENTARY INFORMATION: The Commission is stating its views
with respect to certain problematic practices in connection with
offers and sales under Regulation S, -[1]- the safe harbor under
the Securities Act of 1933 (the "Securities Act")-[2]- for
offshore offerings or resales, and is requesting comment as to
whether specific amendments to Regulation S are necessary to
curtail Regulation S abuses.
In addition, in a companion release, -[3]- the Commission is
publishing for comment rule revisions that would eliminate
certain impediments to registered offerings of securities under
the Securities Act by streamlining requirements with respect to
financial statements of significant acquisitions. Also in the
companion release, rule revisions are proposed that would require
registrants to report on a quarterly basis recent sales of equity
securities that have not been registered under the Securities
Act.
I. INTRODUCTION
The Commission adopted Regulation S in April 1990 in order
to clarify the extraterritorial application of the registration
-------- FOOTNOTES --------
-[1]- 17 CFR 230.901-904.
-[2]- 15 U.S.C. 77a et seq.
-[3]- Securities Act Release No. 7189.
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requirements of the Securities Act.-[4]- Since adoption, a
number of problematic practices have developed involving
unregistered sales of equity securities of domestic reporting
companies purportedly in reliance upon Regulation S. In this
release, the Commission states its views concerning these
problematic practices and is requesting comment as to whether
Regulation S also should be amended to impose additional
restrictions on its use to impede attempts to use the Regulation
to evade the registration requirements of the Securities Act.
Commenters have suggested that companies may be compelled to
sell securities offshore, rather than in registered transactions,
because of the registration disclosure requirements relating to
significant acquisitions. In a companion release, the Commission
is proposing to streamline these requirements to reduce
regulatory impediments to the use of registered offerings. Also,
in response to commenters' suggestions that investors need
information about private or offshore placements of equity
securities that is not currently required to be disclosed, the
Commission is proposing to require quarterly reporting of
unregistered equity offerings. Commenters have suggested this
public reporting may also have the ancillary benefit of deterring
abuses of Regulation S. The Commission in this release is
soliciting comment as to other regulatory burdens that may cause
issuers to resort to offshore offerings rather than registered
public offerings.
II. INTERPRETIVE GUIDANCE ON REGULATION S PRACTICES
Regulation S contains a general statement providing that
Section 5 of the Securities Act -[5]- shall be deemed not to
apply to offers or sales of securities that occur outside the
United States-[6]- and two non-exclusive safe harbors.-[7]-
However, neither of the safe harbors nor the general statement is
available for a transaction or series of transactions that,
although in technical compliance with the regulation, is part of
a plan or scheme to evade the registration requirements of the
Securities Act.-[8]-
Preliminary Note 2 to Regulation S states that "...
Regulation S is not available with respect to any transaction or
series of transactions that, although in technical compliance
with these rules, is part of a plan or scheme to evade the
registration provisions of the Act. In such cases, registration
under the Act is required." This release pertains only to
violations of Section 5 in connection with Regulation S offerings
and does not address issues dealing with the antifraud provisions
of the federal securities laws.
The safe harbors provide specific guidance to issuers and
other market participants as to conditions under which a
transaction will be deemed to occur outside the United States.
-------- FOOTNOTES --------
-[4]- Securities Act Release No. 6863 (April 24, 1990) [55 FR
18306] (the "Adopting Release").
-[5]- 15 U.S.C. 77(e).
-[6]- See Rule 901. Whether a transaction occurs outside the
United States within the meaning of Rule 901 is a
question of the facts and circumstances of the
transaction. See the Adopting Release at footnote 18
and accompanying text.
-[7]- See Rules 903 and 904.
-[8]- See Preliminary Note 2 to Regulation S.
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One safe harbor applies to offers and sales by issuers,
underwriters and other persons involved in the distribution
process pursuant to contract (defined as "distributors") and any
person acting on behalf of the foregoing (the "issuer safe
harbor").-[9]- The other safe harbor applies to resales by
persons other than the issuer, distributors, their respective
affiliates (except certain officers and directors) and persons
acting on behalf of the foregoing (the "resale safe
harbor").-[10]- An offer and sale of securities that satisfies
all conditions of the applicable safe harbor is deemed to be
outside the United States and thus is not subject to the
registration requirements of Section 5, provided that it is not
part of a plan or scheme to evade registration.-[11]-
Since the adoption of Regulation S, it has come to the
Commission's attention that some market participants are
conducting placements of securities purportedly offshore under
Regulation S under circumstances that indicate that such
securities are in essence being placed offshore temporarily to
evade registration requirements with the result that the
incidence of ownership of the securities never leaves the U.S.
market, or that a substantial portion of the economic risk
relating thereto is left in or is returned to the U.S. market
during the restricted period, or that the transaction is such
that there was no reasonable expectation that the securities
could be viewed as actually coming to rest abroad. These
transactions are the types of activities that run afoul of
Preliminary Note 2, would not be covered by the safe harbors and
would be found not to be an offer and sale outside the United
States for purposes of the general statement under Rule
901.-[12]-
-------- FOOTNOTES --------
-[9]- See Rule 903. The issuer safe harbor distinguishes
three categories of securities offerings, based upon
factors such as the nationality and reporting status of
the issuer and the degree of U.S. market interest in
the issuer's securities. Under the issuer safe harbor,
varying procedural safeguards are imposed with the
intent of having the securities offered come to rest
offshore.
-[10]- See Rule 904.
-[11]- Section 5 of the Securities Act prohibits any person,
directly or indirectly, from using instrumentalities of
interstate commerce or the mails to offer or sell a
security unless a registration statement has been filed
or is in effect as to such security. Exemptions from
the registration provisions are set forth in Sections 3
and 4 of the statute, and the related rules promulgated
under the Securities Act. A person who offers or sells
a security in reliance upon an exemption from the
registration requirements of Section 5 has the burden
of establishing the availability of the exemption.
Securities & Exchange Commission v. Murphy, 626 F.2d
633, 645 (9th Cir. 1980). Such exemptions are
construed narrowly. Id. at 641.
-[12]- In addition, a purported Regulation S offering that
involves a distribution in the United States may raise
issues under Rule 10b-6 under the Securities Exchange
Act of 1934. See, e.g., R.A. Holman & Co., Inc. v.
Securities & Exchange Commission, 366 F.2d. 446, at
(continued...)
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The practices described below generally have involved equity
securities of U.S. companies whose securities are traded
principally, and typically solely, in the United States.
There have been a variety of schemes involving parking
securities with offshore affiliates of the issuer or a
distributor. In these transactions, Regulation S is claimed as
the basis to sell securities to offshore shell entities formed by
the issuer or a distributor (or, in some cases, persons closely
associated with the issuer or distributor) to purchase the
securities. The entities hold the securities for the restricted
period; at the end of that period, proceeds from the U.S. sale
make their way, directly or indirectly, to the issuer or
distributor. These transactions do not qualify for either the
Regulation S safe harbor or the Rule 901 general statement since
they are nothing more than sham offshore transactions structured
to evade the Securities Act registration requirements.
Troubling issues also have arisen under the resale safe
harbor provisions of Rule 904. Rule 904 cannot be used for the
purpose of "washing off" resale restrictions, such as the holding
period requirement for restricted securities in Rule 144.-[13]-
Likewise, the restricted status of securities is not affected by
a prearranged transaction by or on behalf of the seller conducted
offshore. If a person with restricted securities sold the
securities in an offshore transaction and replaced them with a
repurchase of fungible unrestricted securities, the replacement
securities would be subject to the same restrictions as those
replaced.
As noted, the Commission has become aware of a number of
instances where the total mix of factors raises the concerns
described above. These factors, any one of which may serve to
indicate that the economic or investment risk never shifted to
the offshore purchaser, and that the securities -- as a matter of
substance as opposed to form -- never left the United States or
remained offshore for less than the restricted period, have
included the use of: (i) non-recourse promissory notes (notes
where the purchaser never is at risk in connection with the
purchase of the securities) for all or almost all of the purchase
price, where the expectation of repayment stems from the resale
of the securities into the U.S. market, (ii) recourse notes where
the entity providing the notes is unknown to the seller of the
securities or the entity has no, or minimal, assets where, again,
the expectation of repayment stems from the resale of the
securities into the U.S. market, (iii) fees paid to the purchaser
of the securities to hold the securities for the restricted
period, whether paid directly or as more frequently seems to be
done through significant-[14]- discounts to the U.S. market price
-------- FOOTNOTES --------
-[12]-(...continued)
449, (2d Cir. 1966) (a distribution of securities is
not deemed to be completed until the securities come to
rest in the hands of the investing public).
-[13]- See Rule 144(d).
-[14]- Of course, some discounts may well be warranted in
order to compensate for the length of the restricted
period, historic volatility of the stock, financial
condition of the issuer, the dilution represented by
the newly issued shares, current market condition,
availability of current information as to the issuer,
information the issuer may have had that was disclosed
to the purchaser but not otherwise disclosed to the
(continued...)
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for the issuer's stock, where the fees or discounts are such to
indicate that the transaction was intended to create a parking
scheme or other scheme where the securities were merely being
held offshore to evade the registration requirements, and (iv)
short selling and other hedging transactions such as option
writing, equity swaps or other types of derivative
transactions,-[15]- where purchasers transfer the benefits and
burdens of ownership back to the United States market during the
restricted period.-[16]-
In these cases it appears the transaction is nothing more
than a delayed sale by the seller in the United States, with the
purported offshore purchaser serving as a statutory
underwriter.-[17]-
-------- FOOTNOTES --------
-[14]-(...continued)
market, or other factors. Nevertheless, some discounts
have been so unrelated to the economics of the
transaction that the only justification that can be
ascertained is that they are part of a parking or
holding scheme where the offshore purchaser is simply
being used as a conduit for what is in reality an
onshore financing.
-[15]- See Securities Act Release No. 7187, Part II.A, which
addresses equity swaps and other like investment
strategies in different contexts.
Securities would not be deemed to have come to rest abroad
during the restricted period if the securities were pledged
as collateral, either in a margin account or otherwise,
where the expectation was that the collateralization would
shift the benefits and burdens of ownership to the lender as
opposed to the purchaser and the lender was not offshore.
-[16]- Since the market for the securities is in the United
States, the short-selling or other hedging transaction
occurs in the United States markets. If the short-
selling or other hedging transaction occurred solely by
or among parties offshore, and the purchaser engaged in
the transaction could reasonably expect that the
economic risk of ownership would remain abroad, then
the transaction could satisfy the requirements of the
rule if the other provisions of Regulation S were
satisfied.
-[17]- Public resales in the United States by persons that
would be deemed underwriters under Section 2(11) of the
Securities Act [15 U.S.C. 77b(11)] would not be
permissible without registration or an exemption from
registration. Footnote 110 of the Adopting Release,
which addresses the restricted periods, should not be
read to provide otherwise.
Section 4(1) of the Securities Act [15 U.S.C. 77d(1)]
exempts "transactions by any person other than an issuer,
underwriter, or dealer." Section 2(11) defines the term
"underwriter" as:
any person who has purchased from an issuer with a view
(continued...)
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III. REQUEST FOR COMMENTS
In addition to taking enforcement action against those who
seek to evade the registration requirements of the Securities Act
under the color of compliance with Regulation S,-[18]- the
Commission is considering whether it is necessary to amend the
regulation to deter these abuses and requests comment as to the
need for revision of Regulation S. A number of proposed
revisions have been suggested by commentators.-[19]- These
suggestions are being considered by the Commission and comment is
requested on each of the proposals that follow. Commentators'
proposals have generally focused on common stock placements by
domestic issuers. Is there a comparable need for such
restrictions in the case of foreign issuers' equity for which the
United States is the sole or principal market, or for any other
class of securities?
1. Extend the Restricted Period. Currently, the
restricted period under the category 2 safe harbor-[20]- for
offerings of securities of domestic companies that are reporting
under the Securities Exchange Act of 1934 (the "Exchange
Act")-[21]- is 40 days. Some have suggested extending the
restricted period, for example, to one year in the case of equity
securities of domestic issuers. One commentator has suggested
that such offerings should be subject to the more restrictive
conditions of the category 3 safe harbor,-[22]- which are
currently generally applicable to offshore offerings by non-
reporting domestic issuers. This would not only extend the
restricted period to one year but also require legending of share
-------- FOOTNOTES --------
-[17]-(...continued)
to, or offers or sells for an issuer in connection
with, the distribution of any security, or participates
or has a direct or indirect participation in any such
undertaking .... As used in this paragraph the term
"issuer" shall include, in addition to an issuer, any
person directly or indirectly controlling or controlled
by the issuer, or any person under direct or indirect
common control with the issuer.
Accordingly, any distributions by a statutory "underwriter"
must be registered pursuant to Section 5. United States v.
Wolfson, 405 F.2d 779, 782 (2d Cir. 1968), cert. denied, 394
U.S. 946 (1969).
-[18]- See, for example, United States v. Sung and Feher,
Litigation Release No. 14500 (May 15, 1995); Securities
and Exchange Commission v. Softpoint, Inc., et al.,
Litigation Release No. 14480 (April 27, 1995).
-[19]- See Ajhar, "Foreign Stock Sales: Don't Get
Blindsided," Worth p. 37 (March 1994); The Corporate
Counsel, March-April 1995; E. Greene, "Recent Problems
Under Regulation S," Insights (August 1994); "Rule
Permitting Offshore Stock Sales Yields Deals that Spark
SEC Concerns", Wall Street Journal, at C1, April 26,
1994.
-[20]- Rule 903(c)(2).
-[21]- 15 U.S.C. 78a et seq.
-[22]- Rule 903(c)(3).
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certificates and an express agreement by the purchaser to resell
the securities only in accordance with an available exemption
from registration.
2. Exclude certain discounted offers from the safe harbor.
Another possible revision would be to limit use of the category 2
safe harbor by domestic issuers offering common stock to those
offerings sold at the market price or with a specified minimal
discount. Those selling at a disqualifying discount could
proceed under Rule 901 if the facts and circumstances established
that the placement was truly an offshore offer and sale and not
part of a plan or scheme to evade the registration requirements
of the Securities Act. Alternatively, rather than exclude some
or all discounted offerings from the issuer safe harbors, should
instead a longer restricted period or all of the category 3
procedures apply to discounted offers?
3. Restrict risk shifting transactions during the
restricted period.
Should the safe harbor require selling restrictions that
limit purchasers' ability during the restricted period to sell
short or otherwise take a short position with respect to, or
otherwise hedge the risk of holding common equity securities?
4. Prohibit payment with certain types of non-recourse or
other types of promissory notes where the expectation of
repayment derives solely from the resale of securities. Should
the category 2 or 3 safe harbor be amended to prohibit (or limit
through tolling of the restricted period) payment for common
equity securities with certain types of non-recourse or other
types of promissory notes where the expectation of repayment
derives solely (or primarily) from the proceeds of resale of the
securities?
IV. THE ROLE OF REGULATION S IN COMPANIES' CAPITAL RAISING PLANS
The Commission, when it adopted Regulation S, understood and
intended that legitimate offshore transactions whereby the issuer
intended that its securities would be sold and placed offshore
would be covered by Regulation S. Regulation S clarified and
simplified procedures for offshore placement of securities and
was intended to provide U.S. issuers with an efficient capital
raising alternative. The Commission understands, in part due to
its participation in the Government-Business Forum on Small
Business Capital Formation, that there are issuers, particularly
those ineligible to use shelf registration, that view offshore
offerings as an important financing alternative. The Commission
is soliciting comments as to the types of companies that are
using Regulation S, how are they using it, and what mechanisms
can be used to prevent abuse without unduly deterring legitimate
offshore capital raising activities.
Reportedly, many small business issuers consider Regulation
S offerings an important financing tool. Is this due to the
increased pool of potential investors, or to the process involved
in accomplishing a Regulation S offering versus a registered
offering, or both? The Commission also recognizes that issuers
may be compelled to sell securities offshore, rather than in
registered transactions, because of registration disclosure
requirements relating to significant acquisitions. As noted
above, in a companion release, the Commission is addressing this
concern through rule proposals to streamline these disclosure
requirements. The Commission is seeking comments as to what
other impediments in the current system may lead to problematic
Regulation S offerings, and what commenters suggest should be
done to alleviate these problems so that resorting to problematic
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Regulation S practices can be eliminated.-[23]-
Further, the Commission requests that commenters address the
benefits and costs and other burdens to investors, issuers, and
other market participants that would result from any of the
suggested changes to Regulation S noted in Section III above.
V. COST-BENEFIT ANALYSIS
The Commission requests views and data relating to the costs
and benefits associated with the proposals relating to additional
restrictions for offerings under Regulation S. It is expected
that such restrictions would not directly impose additional
burdens on companies, although there may be indirect costs
incurred by companies.
VI. REQUEST FOR COMMENTS
Any interested person wishing to submit written comments on
any aspect of the amendments to forms and rules that are subject
to this release are requested to do so. Comments should be
submitted in triplicate to Jonathan G. Katz, Secretary, U.S.
Securities and Exchange Commission, 450 5th Street, N.W.,
Washington, D.C. 20549 and should refer to file number S7-20-95.
List of Subjects in 17 CFR Part 231 Securities.
AMENDMENT OF THE CODE OF FEDERAL REGULATIONS
For the reasons set out in the preamble, Title 17 Chapter II
of the Code of Federal Regulations is amended as set forth below:
PART 231 - INTERPRETATIVE RELEASES RELATING TO THE
SECURITIES ACT OF 1933 AND GENERAL RULES AND
REGULATIONS THEREUNDER
Part 231 is amended by adding Release No. 33-7190 and the
release date of June 27, 1995 to the list of interpretive
releases.
By the Commission,
Jonathan G. Katz
Secretary
-------- FOOTNOTES --------
-[23]- The Commission has established the Advisory Committee
on the Capital Formation and Regulatory Processes (the
"Advisory Committee"), chaired by Commissioner Steven
M.H. Wallman. The Advisory Committee is considering
fundamental issues relating to the regulatory framework
governing the capital formation process, including
whether the current system of registering securities
offerings should be replaced with a company
registration system. The recommendations of the
Advisory Committee may result in rule proposals or
legislative recommendations that, if endorsed by the
Commission, ultimately may address the matters
discussed in this release. Under some of the company
registration models being considered by the Advisory
Committee, the need to draw legal distinctions between
securities issued by registered companies in public
offerings conducted domestically and offshore would be
significantly reduced. All securities issued by
companies registered with the Commission would be
freely tradable in this country, regardless of the
public or private, or domestic or offshore, nature of
that offering.
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June 27, 1995