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Final Rule: Offshore
Offers and Sales (Regulation S)
Part 1 of 2
SECURITIES AND EXCHANGE COMMISSION
17 CFR PARTS 230 and 249
(RELEASE NO. 33-7505; 34-39668; FILE NO. S7-8-97 INTERNATIONAL SERIES RELEASE NO. 1118)
OFFSHORE OFFERS AND SALES
AGENCY: Securities and Exchange Commission.
ACTION: Final Rule.
The Securities and Exchange Commission is adopting amendments to the Regulation S safe harbor procedures for offshore sales of equity securities of U.S. issuers and the reporting requirements applicable to those transactions. The amendments are designed to stop abusive practices in connection with offerings of equity securities purportedly made in reliance on Regulation S.
(60 days after publication in the Federal Register) except §§249.308, 249.308a, 249.308b, 249.310 and 249.310b (the amendments to Forms 8-K, 10-Q, 10-QSB, 10-K and 10-KSB) will become effective on January 1, 1999.
FOR FURTHER INFORMATION CONTACT:
Felicia H. Kung, Office of International Corporate Finance, Division of Corporation Finance, at (202) 942-2990.
The Securities and Exchange Commission (the "Commission") is adopting amendments to Rule 903 1 of Regulation S, 2 the issuer safe harbor under the Securities Act of 1933 3 for offshore offerings of securities, to address abusive practices that have developed. The amendments apply to the offshore sales of equity securities of domestic issuers. The Commission is also adopting amendments to Rule 144(a)(3) 4 and a new Rule 905 5 that classify these equity securities as "restricted securities," as defined in Rule 144 under the Securities Act. In addition, Rule 905 makes clear that offshore resales under Rule 904 6 of restricted equity securities of domestic issuers will not alter the status of these securities as restricted securities after the resale. The Commission also is replacing the current requirement that reporting issuers file a Form 8-K to disclose Regulation S sales of equity securities within 15 days of the transaction with a requirement that these sales be reported on Forms 10-Q, 10-QSB, 10-K or 10-KSB, as appropriate. In addition to these changes, the Commission is adopting other technical amendments to Regulation S to make the rule clearer and more concise.
I. EXECUTIVE SUMMARY
The Commission adopted Regulation S in 1990 as a safe harbor from the registration requirements of the Securities Act for offshore offers and sales of securities. Although the regulation has proved successful for many types of offerings, abuses in connection with sales of domestic equity securities have been common. Regulation S has been used as a means of perpetrating fraudulent and manipulative schemes, especially schemes involving the securities of thinly capitalized or "microcap" companies. These types of securities are particularly vulnerable to fraud and manipulation because little information about them is available to investors.
The Commission is seeking to enhance investor protection with respect to microcap securities through various initiatives, including amendments to Regulation S. The changes to the regulation adopted today should prevent further abuses of this rule, but also allow continued reliance on Regulation S in legitimate offshore offerings.
The Regulation S amendments adopted today are as follows:
The amendments are substantially as proposed with some important differences. To avoid undue interference with offshore offering practices of foreign companies, the amendments will apply to the equity securities of U.S. issuers, but not to the equity securities of foreign issuers. The distribution compliance period applicable to issuers and distributors under Rule 903 will be extended to one year, rather than the proposed two years, to align Regulation S more precisely with the Rule 144 resale restrictions. In addition, promissory notes will not be prohibited in Regulation S transactions; rather, the notes must satisfy certain conditions set forth in Rule 144 before the purchaser can resell pursuant to that rule. These conditions should ensure that promissory notes are not used as a means to distribute securities into the United States. This refined approach will still forestall abuses related to the use of promissory notes in Regulation S transactions. Finally, the change from Form 8-K reporting to quarterly reporting will be delayed to allow the Commission staff to monitor developments under the amended rule.
II. BACKGROUND OF PROPOSALS AND COMMENTERS' CONCERNS
The Commission has acted to stem abuses of Regulation S by issuers, affiliates and others involved in the distribution process who were using Regulation S as a guise for distributing securities into the U.S. markets without the protections to investors of registration of the securities under the Securities Act. The Commission first stated its position about these abuses in a June 1995 interpretive release that described certain problematic practices under Regulation S. 9 The Commission also has instituted enforcement proceedings against participants in abusive Regulation S transactions. 10
As a result of the continuation of certain of these abusive practices and in response to the comment letters received on the Interpretive Release, the Commission on February 20, 1997, proposed new restrictions to Regulation S to stop these abusive practices for placements of equity securities by domestic companies. 11 In addition, the Commission proposed to make these restrictions apply to foreign companies where the principal trading market for their securities is in the United States because of concerns that abusive practices might develop in the future. The Commission proposed to classify these equity securities of domestic and foreign companies placed offshore under Regulation S as "restricted securities" within the meaning of Rule 144, and to revise the applicable offering restrictions to ensure that these equity securities could not be sold or resold to U.S. persons (unless pursuant to registration or an exemption). 12
The comments on the proposals were mixed. 13 A number of commenters supported the proposed amendments as necessary and appropriate to curb abusive practices and to facilitate legitimate offshore capital raising by U.S. companies. Others believed the proposals would severely restrict the ability of U.S. companies to access alternative offshore sources of capital. Several commenters objected to the extension of the revisions in the rule to foreign private issuers that have their principal market in the United States. These commenters urged that the application of the new resale restrictions, including the legending and stop transfer requirements, would be inconsistent with the requirements of offshore trading markets and public offering practices.
III. AMENDMENTS ADOPTED TODAY
A. Scope of the Amendments
1. Will Not Apply to Foreign Issuers for Which the United States is the Principal Market
Although abusive practices under Regulation S have not been evident in offerings by foreign issuers, the Commission was concerned that abusive practices might develop in the future since the economic incentives for indirect distributions and resales into the United States are the same for equity offerings of both domestic companies and foreign companies where the principal market for their securities is in the United States. 14 Therefore, the Commission proposed that the Regulation S changes would treat these offerings similarly both with respect to the new Regulation S requirements, as well as the "restricted securities" classification under Rule 144.
The commenters strongly opposed this approach. They pointed out that subjecting foreign issuer securities to these restrictions was unnecessary in light of the absence of abuses with respect to those securities. They also asserted that there should be no presumption that a foreign issuer offering securities overseas is doing so to avoid the registration and disclosure requirements of the U.S. federal securities laws, even when it has a substantial trading market for its securities in the United States. Moreover, in the view of some these commenters, there is no reason to assume that indirect unregistered distributions into the United States will occur when these foreign issuers' securities are sold offshore.
The commenters also noted that if equity securities issued by these foreign companies are deemed restricted securities, the issuers in essence would be applying to their offshore offerings many of the standard practices used in U.S. private placements. The certification and purchaser agreement requirements would impose a significant burden on foreign issuers that wish to conduct public offerings in their home jurisdictions. In addition, many foreign stock exchanges will not permit trading of legended securities. The commenters asserted that the legending and stop transfer restrictions, as well as to a lesser extent the disclosure and certification requirements that would be imposed by the rule, would impede both public offerings and trading in those securities on offshore public markets that do not accept legended stock for trading. 15 As a result, the classification of foreign equity securities as "restricted" could create a strong disincentive for foreign companies to list their securities on U.S. markets.
While the Commission remains concerned with the potential for abuse, it has determined not to extend, at this time, the new requirements to the securities of foreign private issuers, regardless of the relative size of their U.S. markets to their worldwide trading. 16 The Commission agrees that absent a showing of abuse, imposing significant new restrictions on the offshore offering practices of foreign companies is not warranted. However, the Commission will monitor practices in this area, and will revisit the issue if abuses occur. Meanwhile, purchasers of these securities are reminded that Regulation S does not provide a safe harbor for resales of securities into the United States, and any resales must be made pursuant to a registration statement or an exemption from the Securities Act. Regardless of the foreign issuer's compliance with the Regulation S requirements, purchasers cannot purchase securities and resell them into the United States under circumstances in which they would be deemed statutory underwriters unless they register those resales. 17
2. Will Apply to Public Offerings
Several commenters expressed the view that the proposed restrictions, including the designation of equity securities issued under Regulation S as restricted securities, were inconsistent with offshore public offering practices and the requirements of foreign trading markets. These commenters urged the Commission to adopt a distinction based on whether there was or will be a public trading market for the securities offshore following the offer, or whether the offering was subject to a foreign regulatory scheme governing public offerings.
Since most of the concerns in this respect were raised with regard to the extension of the requirements to foreign private issuers, those concerns are substantially addressed by the Commission's decision to limit the applicability of the new restrictions to domestic issuers. As discussed below, 18 the Commission believes that offering practices can be adopted to allow the new restrictions to be applied in the context of a public offering by domestic issuers, including share acquisitions. The existence of an offshore trading market would not eliminate the potential for abuse; for example, an offering could be made at a discount to purchasers offshore who may engage in an illegal distribution back into the United States. The Commission also is concerned that otherwise limited distributions to a small group of offshore investors easily could be structured as underwritten public offerings to avoid any additional restrictions on resales by those investors back into the United States. Accordingly, the amendments do not incorporate a distinction based upon whether a public trading market for the securities exists offshore, or whether the securities were issued in a public offering.
3. Will Apply to All Equity Securities of Domestic Companies, Including Convertible Securities
Consistent with the proposal, the new procedures and restrictions and the "restricted securities" classification will apply only to offerings of equity securities. Rule 405 of Regulation C under the Securities Act defines the term "equity security" to include stock, securities convertible or exchangeable into stock, warrants, options, rights to purchase stock, and other types of equity-related securities. 19 The Commission is not applying the new restrictions to offerings of straight debt securities because the nature of the trading markets for debt securities appears not to have facilitated similar abusive practices. However, the new restrictions will apply to offerings of convertible debt securities because Regulation S abuses have involved the use of convertible or exchangeable securities and warrants. 20
Commenters addressing the issue of whether the restrictions should apply to convertible securities urged the Commission to adopt the approach incorporated into Rule 144A. Under that approach, a convertible security is not treated as the same class as the underlying equity security if it has a conversion premium exceeding a specified percentage threshold over the market price of the underlying securities at the time of issuance. 21 If this approach were used in Regulation S, convertible securities with a sufficient conversion premium would not be subject to the new restrictions applicable to equity.
The new rules and restrictions will apply to all equity securities of U.S. issuers, including exchangeable or convertible securities and warrants, without regard to the conversion or exercise premium or other factors. It is clear that these securities can and have been used in abusive transactions. The potential for abuse exists whenever a domestic issuer can create offshore, in a transaction not subject to the registration provisions of the U.S. securities laws, pools of equity securities that appear to be immediately tradeable back into the United States because of their unrestricted status. The Commission is reluctant to specify a conversion premium and thus possibly be viewed as condoning abusive practices in securities set above that threshold. In any event, given the volatility of the markets for the types of small capitalization companies in which the Commission has witnessed abuses, it would be difficult to set an appropriate threshold for all types of issuers. Finally, as discussed below, even with application of the new restrictions to convertible securities, the Commission does not believe that Regulation S will eliminate the use of these securities as a means to lower a U.S. issuer's cost of capital. Many issuers do not need to rely on Regulation S with respect to their sales of convertible securities because they can use Form S-3 to register the securities.
4. Will Apply to Securities in Employee Benefit Plans
Equity securities offered and sold to non-U.S. resident employees through an employee benefit plan governed by foreign law have not been subject to a distribution compliance period regardless of the domicile of the issuer or U.S. market interest in its securities. Since new Rule 905 would extend to all equity securities of domestic issuers, however, the proposals would classify those equity securities as restricted securities within the meaning of Rule 144 when issued to the employee.
Several commenters believed that it was inappropriate to require non-U.S. resident employees to accept restricted securities pursuant to their employee benefit plans. To the extent reporting U.S. issuers believe it is necessary to give their non-U.S. resident employees immediate access to the U.S. public markets in order to sell the security, Form S-8, which is effective immediately upon filing, is available to permit the issuer to register the securities on a streamlined basis. Consequently, the Commission has determined to apply Rule 905 to these securities as proposed.
B. Distribution Compliance Periods
-- 17 CFR 230.903.
-- 17 CFR 230.901 - 230.905 and Preliminary Notes.
-- 15 U.S.C. 77a et seq.
-- 17 CFR 230.144(a)(3).
-- 17 CFR 230.905.
-- 17 CFR 230.904.
-- Rule 905, which classifies these securities as "restricted," will not be applied retroactively. See infra Section III.C.3.
-- 17 CFR 230.901.
-- Securities Act Release No. 7190 (June 27, 1995) (60 FR 35663(July 10, 1995)) (the "Interpretive Release").
-- See SEC v. Schiffer , Litigation Release No, 15435 (Aug. 7, 1997); In re GFL Ultra Fund Ltd. , Securities Act Release No. 7423 (June 18, 1997); SEC v. PanWorld Minerals Int'l, Inc. , Litigation Release No. 15380 (June 2, 1997); SEC v. Members Service Corp. , Litigation Release No. 15371 (May 22, 1997); SEC v. Rosenfeld , Litigation Release No. 15274 (Mar. 5, 1997); United States v. Sung and Feher , Litigation Release No. 14901 (May 6, 1996); In re Candie's, Inc. , Securities Act Release No. 7263 (Feb. 21, 1996); SEC v. Scorpion Technologies, Inc. , Litigation Release No. 14814 (Feb. 9, 1996); SEC v. Sarivola ; Litigation Release No. 14704 (Oct. 31, 1995); SEC v. EnvirOmint Holdings, Inc. , Litigation Release No. 14683 (Oct. 6, 1995); SEC v. Softpoint, Inc. , Litigation Release No. 14480 (Apr. 27, 1995); SEC v. Rehtorik , Litigation Release No. 13975 (Feb. 23, 1994); SEC v. Westdon Holding & Inv., Inc. , Litigation Release No. 13263 (June 5, 1992).
-- Securities Act Release No. 7392 (Feb. 20, 1997)(62 FR 9258 (Feb. 28, 1997))(the "Proposing Release").
-- The Commission proposed to revise the offering restrictions imposed by Regulation S by: (1) aligning the Regulation S restricted period for these equity securities with the Rule 144 holding periods by lengthening the restricted period from 40 days or one year, as applicable, to two years; (2) by imposing certification, legending and other requirements; (3) by requiring purchasers of these securities to agree not to engage in hedging transactions unless the transactions comply with the Securities Act; (4) by prohibiting the use of promissory notes to pay for these securities; and (5) by clarifying that offshore resales of equity securities that are "restricted securities," as defined in Rule 144, will not "wash off" the restricted status of these securities.
-- The 47 comment letters received are available for inspection and copying in the Commission's public reference room. Refer to file number S7-8-97. The twelve comment letters that were submitted via electronic mail may be viewed at the Commission's web site: http://www.sec.gov.
-- The Commission proposed defining "principal market in the United States" for a security as when more than 50% of all trading in such class of securities took place in, on or through the facilities of securities exchanges and inter-dealer quotation systems in the United States in the shorter of the issuer's prior fiscal year or the period since the issuer's incorporation. This definition differs from the "substantial U.S. market interest" test that is used to determine whether a foreign issuer qualifies for less restrictive treatment under Category 1 of Rule 903. See Proposing Release at Section II.
-- A number of commenters also noted that the 50% threshold for determining the principal market as being in the United States that was proposed by the Commission was too low and would make the restrictions applicable to a large number of foreign issuers. One commenter noted that even if the standard were 100% of the reported trading volume, 10% of the foreign companies listed in the United States are traded solely in the United States and would be subject to the new requirements. See generally, "U.S. Investors Look Across the Atlantic," THE WASHINGTON POST, Aug. 31, 1997, at H2 (because of U.S. investor interest in foreign stocks, the New York Stock Exchange may be the principal market for many leading European companies).
-- The Commission currently is considering other alternatives to prevent fraudulent practices that may occur in connection with the securities of foreign issuers. See Securities Exchange Act Release No. 34-39670 (Feb. 17, 1998).
-- See Interpretive Release at n.17; Proposing Release at n.41.
-- See infra Section III.C.1.
-- 17 CFR 230.405. Under the amendments adopted today, non-participating preferred stock and asset-backed securities would continue to be treated in the same manner as debt securities for purposes of the Regulation S safe harbors and the restricted security classification. See Rule 902(a)(17 CFR 230.902(a)), (formally Rule 903(c)(4)).
-- See "Pirates' Play?", BARRON'S, Jan. 7, 1997, at 17.
-- See Rule 144A(d)(3)(i) (17 CFR 230.144A(d)(3)(i)). See also Securities Act Release No. 6862 (Apr. 23, 1990) (55 FR 17933 (April 30, 1990)) at nn.25 and 26 for a discussion of how the conversion or exercise premium is determined for purposes of Rule 144A.