[Federal Register Volume 60, Number 131 (Monday, July 10, 1995)]
[Rules and Regulations]
[Pages 35663-35666]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16393]
Federal Register / Vol. 60, No. 131 / Monday, July 10, 1995 / Rules
and Regulations
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[[Page 35663]]
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.
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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 July 10, 1995. 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.
\1\ 17 CFR 230.901-904.
\2\ 15 U.S.C. 77a et seq.
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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.
\3\ Securities Act Release No. 7189.
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I. Introduction
The Commission adopted Regulation S in April 1990 in order to
clarify the extraterritorial application of the registration
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.
\4\ Securities Act Release No. 6863 (April 24, 1990) [55 FR
18306] (the ``Adopting Release'').
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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
\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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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. 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
\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.
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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
\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 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).
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.
\13\ See Rule 144(d).
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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 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
\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 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.
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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
\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 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).
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
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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?
\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.
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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 certificates and an express
agreement by the purchaser to resell the securities only in accordance
with an available exemption from registration.
\20\ Rule 903(c)(2).
\21\ 15 U.S.C. 78a et seq.
\22\ Rule 903(c)(3).
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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 Regulation S
practices can be eliminated.23
\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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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, NW., Washington, DC 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:
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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.
Dated: June 27, 1995.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-16393 Filed 7-7-95; 8:45 am]
BILLING CODE 8010-01-P
