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Final Rule:  Offshore Offers and Sales (Regulation S)
Source: U.S. Securities and Exchange Commission

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B.  Distribution Compliance Periods

As explained in greater detail in the Proposing Release, 22 the issuer safe harbor distinguishes three categories of securities offerings, based upon factors such as the jurisdiction of incorporation of the company whose securities are being sold, the company's reporting status under the Securities Exchange Act of 1934 ("Exchange Act"), 23 and the degree of U.S. market interest in the issuer's securities.  24 The Commission proposed shifting U.S. reporting companies to "Category 3" and lengthening the distribution compliance period applicable to domestic equity securities. The effect of the proposals would have been to lengthen the distribution compliance period for U.S. reporting companies from 40 days to two years. Issuers previously subject to Category 3 for their equity offerings -- non-reporting domestic issuers and foreign issuers with a significant U.S. market interest for their securities -- would have had their distribution compliance period extended from one to two years. During this period, issuers, distributors, and their affiliates would have been required to comply with the documentation and disclosure requirements imposed by Rule 903, and any offers and sales during this period could not be made to a U.S. person and still qualify for the safe harbor. In response to concerns raised by commenters, the Commission is adopting a modified version of these proposals.

In addition, to further avoid confusion between the requirements applicable to issuers and distributors as a condition to perfecting their Rule 903 safe harbor and the Rule 144 safe harbor applicable to resales of the securities into the United States by the purchasers of those securities, the restricted period has been renamed the "distribution compliance period." This should clarify that the availability of the safe harbor to the issuer and distributors has no bearing on whether purchasers of Regulation S securities may be acting as statutory underwriters if they purchase with a view to reselling into the U.S. markets.

1.  Extension of the Distribution Compliance Period

A distribution compliance period is required for Category 2 and Category 3 offerings under the issuer safe harbors because there is a greater likelihood that the securities will flow back into the United States. The purpose of the distribution compliance period is to ensure that during the offering period and the subsequent aftermarket trading that takes place offshore, the persons relying on the safe harbor -- issuers, distributors and their affiliates -- are not engaged in an unregistered, non-exempt distribution into the United States capital markets.  25 In addition to the prohibition against selling to U.S. persons during the distribution compliance period, these persons are subject to special requirements designed to provide assurance that the securities will come to rest offshore.

The Commission proposed the two-year distribution compliance period to make the restrictions on issuers and distributors consistent with the Rule 144 holding periods applicable to purchasers of the Regulation S securities under new Rule 905 and the amendments to Rule 144. The commenters generally agreed that the current 40-day distribution compliance period was insufficient to protect against use of an offshore offering to make an indirect offering into the United States, at least with respect to equity securities of domestic issuers. Some commenters argued, however, that the two-year period was not necessary and that a 90-day period, like that originally proposed when Regulation S was first formulated, would be sufficient.  26

Consideration was given to eliminating the distribution compliance period altogether, on the premise that since the equity securities issued under Regulation S could not be sold back into the U.S. markets for a period of two years unless sold in a manner consistent with the Rule 144 requirements, the additional requirements of the distribution compliance period were unnecessary. However, the documentation, disclosure and certification requirements linked to the distribution compliance period, as well as the prohibition against offers and sales to a U.S. person during the distribution compliance period, provide important additional protections and assurance that, at least from the perspective of the distribution participants, the securities have come to rest offshore. Extending those requirements for a period of time after the closing of the offering is necessary, particularly with respect to distributors of those securities who may immediately make a market for the securities offshore. The purposes of the protections would be defeated if the requirements are applied only to the initial purchasers.

The Commission has decided to extend the distribution compliance period substantially beyond 40 days to one year. The expiration of the one-year period will coincide with the period when limited resales may begin under Rule 144. At that point, the distribution compliance period is unnecessary. A two-year distribution compliance period, as originally proposed, could be confusing to apply because the distribution compliance period under Regulation S would cover a longer period than the holding period under Rule 144.

2.  Offering Restrictions

Category 2 and Category 3 of Rule 903 require that "offering restrictions" 27 be implemented during the distribution compliance period. For offerings classified as Category 3, these offering restrictions include agreements by distributors that the securities will only be sold in accordance with the Securities Act or Regulation S, and a requirement for disclosure in all offering materials to the same effect. The amendments adopted today do not affect these requirements other than to:

  • lengthen the period during which they must be implemented, as a result of the lengthening of the distribution compliance period; and

  • require that additional language be provided in the mandated agreements and on the securities themselves, so that purchasers have notice that hedging transactions not in compliance with the Securities Act are prohibited.

3.  Purchaser Agreements and Certifications

Category 3 imposes additional requirements not included in Category 2 relating to purchaser certifications and agreements. Those requirements will be imposed on equity offerings of domestic reporting companies for the first time under the amendments. In addition, the issuer and distributors will be subject to the additional requirements for a longer period, as a result of the longer distribution compliance period.

In keeping with a more restrictive approach to the types of Regulation S offerings where the Commission has observed the greatest potential for abuse, the Commission is adopting amendments that will require purchasers of equity securities in Category 3 offerings to agree to resell the securities, or to engage in hedging transactions, only in accordance with the registration or exemptive provisions of the Securities Act, or in accordance with Regulation S. 28 This agreement by purchasers of the covered equity securities should help ensure that purchasers have notice of the resale restrictions applicable to the securities. Purchasers of domestic equity securities of reporting companies also will now be required to certify that they are not U.S. persons and are not acquiring the securities for the account or benefit of a U.S. person, or that they are U.S. persons who purchased securities in a transaction that did not require registration under the Securities Act. This certification procedure should make it clear to all parties involved in the Regulation S offering that the rule may not be used to circumvent the registration requirements of the Securities Act. This should prevent some of the "sham" transactions described in the Interpretive Release where issuers or distributors "park" securities offshore with affiliates or shell entities that are actually owned by U.S. persons.

4.  Legending and Stop Transfer Requirements

Under the amendments, Category 3 will now require all domestic issuers of equity securities to place a legend on the securities sold offshore under Regulation S. This legend will advise that transfer of such securities is prohibited other than in accordance with Regulation S, pursuant to registration under the Securities Act, or pursuant to an available exemption from registration. The legend requirement will provide notice to any subsequent purchasers of the resale restrictions applicable to the securities. Legending equity securities of domestic reporting issuers until the expiration of the current 40-day distribution compliance period appears to be a common practice under Regulation S. The extension of the express legending requirement to reporting companies, when limited to domestic issuers, should not impose a different or new burden. In addition, as proposed, the current legending requirement is being amended, so that purchasers are aware that hedging transactions may not be conducted except in compliance with the Securities Act.

Category 3 also requires an issuer, by contract or a provision in its bylaws, articles, charter or comparable document, to refuse to register any transfer of securities unless made in accordance with the registration or exemptive provisions of the Securities Act, or in accordance with Regulation S. This requirement imposes on issuers a monitoring role similar to that which is often imposed in connection with unregistered private placements. In light of the abuses in this area, domestic reporting issuers should be held more accountable for compliance in these offerings.

Commenters were concerned that these procedures -- which have existed under Category 3 since before the adoption of Regulation S 29 and now are merely being extended to a broader class of issuers - are inconsistent with public offering practices and that imposing these requirements will prevent the issuer from engaging in offshore public offerings or listings. Since these concerns were raised principally with respect to foreign issuers, they have been addressed by the decision not to extend Category 3 to reporting foreign issuers that have their principal market in the United States.  30 With respect to domestic issuers, although these requirements will not be complied with easily in an offshore public offering, the need to develop mechanisms to prevent abuse is clear. Absent measures like those required in Category 3, the Commission is concerned that abusive practices will continue.  31 Domestic reporting companies that find it too cumbersome to take advantage of the Regulation S safe harbor when conducting a public offering would simply register under the Securities Act or resort to other exempt offerings.

C.  New Rule 905 -- Restricted Securities

Because some of the abusive practices under Regulation S have involved activities by persons other than issuers, distributors and their affiliates (investors who purchase Regulation S securities with a view to distributing those securities into the U.S. markets at the end of the 40-day distribution compliance period), the Commission believes that it is appropriate to clarify the legal obligations of purchasers of securities under Regulation S. The Commission proposed new Rule 905, and amendments to Rule 144(a)(3), to classify covered equity securities (of both reporting and non-reporting issuers) placed offshore under Regulation S as "restricted securities" within the meaning of Rule 144. By expressly defining these Regulation S securities as falling within the definition of "restricted securities" under the Rule 144 resale safe harbor, purchasers of those securities are provided with clear guidance regarding when and how those securities may be resold in the United States without registration under the Securities Act.

Several commenters believed that subjecting offshore purchasers of Regulation S securities to the Rule 144 holding periods would impair liquidity in those securities to such an extent that the safe harbor would no longer provide an alternative source of capital for U.S. companies. Instead, U.S. issuers would either have to register the offering or rely on a separate exemption, such as Regulation D or Section 4(2) under the Securities Act for private offerings.

1.  Advantages of Regulation S

Notwithstanding the concerns raised by commenters, the Commission believes Regulation S will continue to offer significant advantages over the private offering exemptions. U.S. issuers can sell securities offshore without regard to the sophistication or number of purchasers in the offering or the size of the offering. Similarly, unlike Rules 505 and 506 of Regulation D, Regulation S does not contain specific information requirements. In addition, Regulation S permits issuers and distributors to advertise an offering offshore (consistent with the prohibition against directed selling efforts and the offshore transaction requirements) in a manner that would not be consistent with the prohibition against general solicitation in a private placement in the United States. Like the private offering exemptions, Regulation S will continue to afford U.S. issuers a means to sell securities without the potential delay and "market overhang" caused by registering equity securities under the Securities Act.

Purchasers will continue to have several sources of liquidity in addition to reliance on Rule 144. Offshore purchasers can continue to rely upon the Rule 904 safe harbor for offshore resales. They can also resell in the United States pursuant to exemptions other than Rule 144, including Rule 144A. Finally, and perhaps most importantly, it is possible that purchasers in Regulation S offerings could insist upon registration rights as do purchasers in private placements under Section 4(2) or Regulation D as a means of obtaining liquidity in the U.S. markets.  32 Particularly in the case of reporting companies, a Regulation S offering coupled with on demand registration rights provides an issuer with ready access to foreign capital while according purchasers access to U.S. markets for liquidity.  33

2.  Resales of Restricted Securities

Rule 905 also addresses the resale of restricted securities under Rule 904. Rule 905 clarifies that the resale of restricted securities offshore under Rule 904 does not "wash off" the restricted status of those securities to allow them to be freely resold into the United States by the purchaser. Several commenters argued that it was impossible to keep track of the restricted status of securities trading in offshore securities markets. With the widespread adoption of uncertificated securities and rules of offshore markets that prohibit the listing of legended securities, these commenters observed that the approach simply was not practicable.

By not extending Rule 905 to securities of foreign private issuers, the principal concerns of the commenters in this respect should be addressed.  34 Although some commenters have expressed concern that the certification and legending requirements may hinder free trading on offshore securities markets, without these requirements the potential for easy evasion of Rule 144's resale limitations for domestic equity securities is high. Absent the mandatory certification and legending requirements, the purchaser would not be on notice that it is subject to any restrictions on the resale of those securities into the United States.  35 It is possible that some markets can accommodate such securities, or may adapt to accommodate them in the future. Consequently, the Commission is adopting Rule 905 as proposed for domestic equity securities.

3.  Retroactive Application of Rule 905

Rule 905 will not be applied retroactively to classify domestic equity securities previously sold under Regulation S as restricted securities under Rule 144. However, the provision of Rule 905 that codifies the Commission's interpretive position that resales offshore do not "wash off" restrictions will apply to offerings taking place before the effective date. This position was stated in the Interpretive Release and reiterated in the Regulation S Proposing Release.

D.  Promissory Notes

Under the proposal, Regulation S would have prohibited the use of promissory notes or other executory obligations as payment for domestic equity securities. The proposal was designed to address abuses where the offshore purchaser used a promissory note to pay all or a portion of the purchase price of the securities. In some cases, the notes were secured only by the Regulation S securities; in other cases, the notes were unsecured. Some notes provided recourse to the buyer if the note was not repaid; others did not. Purchasers have resold the securities into the U.S. markets upon expiration of the 40-day distribution compliance period and used the proceeds of the resale to repay the note. Under such an arrangement, the issuer and purchaser clearly expect a U.S. resale to provide the funds necessary to repay the note; in economic substance, the issuer is raising funds from the U.S. public markets.

Rather than exclude such transactions from the coverage of the safe harbor, some commenters recommended that the Commission adopt the alternative approach suggested in the Proposing Release -- that is, to toll the holding period under Rule 144 until certain conditions are satisfied, similar to the tolling approach taken under Rule 144 with respect to promissory notes and other similar obligations. The Commission has decided to adopt this approach because it is persuaded that this approach will address concerns about the use of promissory notes to raise funds in the U.S. markets, since the securities purchased pursuant to Regulation S will be fully paid for before the securities can be resold into the U.S. markets pursuant to Rule 144. In that case, the resale of the securities into the U.S. markets under Rule 144 would not be used to raise funds to repay the promissory note. Under the approach adopted, promissory notes or similar obligations or contracts can be accepted as payment to purchase domestic equity securities under Regulation S. The holding period will not begin to run for the purchaser, however, unless the following conditions are satisfied: the promissory note, obligation or contract provides for full recourse against the purchaser of the securities, and is secured by collateral (other than the securities purchased) having a fair market value at least equal to the purchase price of the securities purchased. In addition, after the holding period requirement has been satisfied, the promissory note, obligation or contract must be paid in full before the resale of the securities under Rule 144. This ensures that the funds obtained through the Rule 144 resales will not be used to pay off the promissory note.

E.  Reporting of Regulation S Transactions

As a result of amendments adopted by the Commission in October 1996, 36 sales of equity securities by domestic issuers under Regulation S are required to be reported on Form 8-K within 15 days of occurrence. All other unregistered sales of equity securities by domestic issuers (e.g., private placements) must be reported quarterly in the issuer's Form 10-Q and in its Form 10-K (for the last fiscal quarter). At the time the Commission adopted the Form 8-K 15-day reporting requirement, the Commission stated that if it extended the distribution compliance period for sales of equity securities under Regulation S, it would consider revising the reporting requirement.

The commenters generally favored dropping the Form 8-K requirement, although some thought that the Form 8-K report was important to stop abuses, and provided timely notice to shareholders and the markets of a material development concerning the issuer. Since equity securities sold under Regulation S will now be deemed restricted securities and thus cannot enter the U.S. public markets any faster than securities issued in an exempt private placement, the benefits of expedited Form 8-K reporting is minimal. Accordingly, the Form 8-K filing requirement is being eliminated, and these sales will be reported on Forms 10-Q, 10-QSB, 10-K or 10-KSB, as applicable.  37

The Commission has determined to delay the effectiveness of this amendment, however, to allow the Commission staff to monitor closely developments under the amended Regulation S safe harbor procedures during a transition period. Accordingly, the Form 8-K report will not be required for any Regulation S sales occurring after January 1, 1999.

Following the October 1996 adoption of the Form 8-K reporting requirement, the Commission staff received inquiries regarding the need to report on Form 8-K unregistered sales of equity securities by U.S. companies to their non-U.S. resident employees pursuant to employee benefit plans. To the extent that the sales qualify for Category 1 treatment under Rule 903 of Regulation S, issuers may report the sales on an aggregated basis on the Form 10-Q, rather than on a current basis on Form 8-K, prior to January 1, 1999.

F.  Technical And Clarifying Revisions

As proposed, the Commission is adopting non-substantive technical and clarifying revisions to Regulation S to make the rule more concise and understandable. The principal changes include:

  • revising the captions of the three sections of the Rule 903 issuer safe harbor to refer to them as commonly known: "Category 1," "Category 2" and "Category 3";

  • revising the Rule 903 issuer safe harbor to state clearly for each category what procedures are to be followed and what securities are eligible for each category;

  • combining some definitions within Rule 902, the definition section of Regulation S, and moving certain definitions to the Rule 903 safe harbor to make the rule easier to read and understand;

  • updating the list of "designated offshore securities markets" in Rule 902;

  • if the same terms are already defined elsewhere in the Commission's rules and regulations, deleting those definitions from Rule 902 and adding cross-references to the definitions contained elsewhere; and

  • generally editing the language in the rule to make it more understandable.

IV.  CERTAIN FINDINGS

Section 23(a) of the Exchange Act 38 requires the Commission to consider any anti-competitive effects of any rules it adopts thereunder and the reasons for its determination that any burden on competition imposed by such rules is necessary or appropriate to further the purposes of the Exchange Act. Furthermore, Section 2 39 of the Securities Act and Section 3 40 of the Exchange Act, as amended by the National Securities Markets Improvement Act of 1996, 41 provide that whenever the Commission is engaged in rulemaking and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission also shall consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation.

The Commission has considered the amendments discussed in this release in light of the comments received in response to the Proposing Release and the standards in Section 23(a) of the Exchange Act. 42 The Commission adopted Regulation S in 1990 to provide a safe harbor from the registration requirements of the Securities Act for offshore offers and sales of securities. Since the adoption of Regulation S, the Commission has become aware of abuses of this rule in connection with sales of domestic equity securities. The Commission is adopting the amendments to prevent further abuses of this rule.

In compliance with Section 2 of the Securities Act, which requires the Commission to consider whether the action will promote competition, it is important to note that the amendments will impose certain burdens on purchasers of equity securities issued by domestic companies, as well as on the issuers themselves, that may place domestic issuers at a competitive disadvantage in raising funds through Regulation S transactions as compared to foreign issuers. For example, purchasers of domestic equity securities sold pursuant to Regulation S may have to wait a longer period of time before they can publicly resell the securities into the United States. In addition, these purchasers will have to provide certification that they are not U.S. persons that may result in additional record keeping burdens on issuers and distributors who must maintain records of this compliance. Of course, any U.S. law applicable only to U.S. issuers will have some competitive effect on domestic issuers compared to foreign issuers. However, the Commission believes that such restrictions are necessary to deter abuses of the rule. Because abusive practices under Regulation S primarily have involved domestic companies, the Commission believes that it is not necessary at this time to apply additional restrictions on sales of equity securities by foreign issuers.

Although the amendments will impose certain burdens on both purchasers and issuers of equity securities issued by domestic companies, the Commission anticipates that the overall effect of the amendments will be to enhance efficient capital formation. By deterring abusive market practices, the amendments will protect investors and promote capital formation by enhancing investors' confidence in the integrity of Regulation S offerings.

The Commission is adopting amendments to relax the requirements to report unregistered sales of equity securities made pursuant to Regulation S. Such sales will now be reported on a delayed basis on Forms 10-Q, 10-QSB, 10-K and 10-KSB, rather than Form 8-K. However, investors will continue to have sufficient information regarding changes in outstanding securities of public companies. These amendments could decrease Form 8-K filing burdens for some reporting issuers, although the new requirements to report unregistered equity sales on a quarterly basis could result in an offsetting increase in reporting. Nonetheless, the Commission believes the amendments will promote efficiency and capital formation, and will not unnecessarily burden competition.

FOOTNOTES

-[22]- See Proposing Release at Section II.

-[23]- 15 U.S.C. 78a et seq.

-[24]- See discussion at nn.13-16 of the Proposing Release.

-[25]- See Securities Act Release No. 6863 (Apr. 24, 1990)(55 FR 18306(May 2, 1990))(the "Adopting Release") at Section III.B.

-[26]- The longer distribution compliance periods also extend the time during which the issuer and distributors could not engage in directed selling efforts in the United States. See Adopting Release at Section III.B.1.b. One commenter expressed concern that the two-year distribution compliance period places an unworkable "black-out" restriction on publication of research regarding the issuer's securities.

-[27]- The term "offering restrictions," as amended, is defined in Rule 902(g) (17 CFR 230.902(g)).

-[28]- Issuers, however, would be free to require purchasers to agree not to engage in any hedging transactions, even if the transaction would be consistent with the Securities Act. The amendments do not impose any new restrictions on hedging practices. The Commission is considering proposed restrictions on hedging under Rule 144 that, if adopted, would be in addition to those currently applicable to restricted securities transactions under that rule. See Securities Act Release No. 7391 (Feb. 20, 1997) (62 FR 9246 (Feb. 28, 1997)) ("Rule 144 Proposing Release")(discusses current and proposed restrictions on hedging restricted securities).

-[29]- See, e.g. , InfraRed Associates, Inc., SEC No-Action Letter (Sept. 13, 1985).

-[30]- The Category 3 requirements, other than legending, already apply to equity offerings by non-reporting foreign issuers where there is a substantial U.S. market interest in the security. The amendments do not affect this aspect of Rule 903.

-[31]- As the Commission noted in the Proposing Release: Regulation S does not require, and the Commission is not proposing, that the legend contain specific language to describe these restrictions. Issuers and distributors should prepare such legends in a form that conveys to holders the restricted nature of the securities and that they can only be resold under Regulation S, pursuant to registration under the Act, or under an exemption. Nor is the legend requirement intended to require that securities sold under Category 3 be in certificated form. Issuers whose securities are in uncertificated form may satisfy the legend requirement by any means which puts holders and subsequent purchasers on notice of the applicable resale restrictions. Proposing Release at Section III.B.4. Depending on the circumstances, the following alternatives, among others, may be sufficient to put holders on notice and prevent a public distribution into the United States: notices of the restrictions to investors on the confirmation or allotment telex, use of global securities held in a depository, and restrictions on trading in the United States through the use of restricted CUSIP numbers.

-[32]- Form S-3 (17 CFR 239.13) is generally available for these types of resale registration statements, even for companies that do not meet the public float requirement for primary offerings under Form S-3, if the securities are listed on a U.S. securities exchange or quoted in the Nasdaq Stock Market.

-[33]- The Commission proposed to amend Rule 903 to make clear that registered or exempt sales to U.S. persons during the distribution compliance period would not impair reliance on Regulation S. Language instead has been added to Preliminary Note 5 to make clear that registered offers and sales to U.S. persons, or offers and sales made pursuant to an exemption such as Rule 144A, are permitted during the distribution compliance period without jeopardizing the issuer's reliance on Regulation S for the offshore offers and sales.

-[34]- For example, because of its limited scope there should be no basis for a concern that Rule 905 could restrict the ability of a foreign security that was privately placed in the United States to be sold back into its home market offshore in a Rule 904 or Rule 144A transaction.

-[35]- The Commission is adopting the proposed amendment to Rule 144(e)(3)(vii) that codifies the Commission staff's informal position that restricted securities resold offshore pursuant to Regulation S need not be included in the amount of securities that have been resold pursuant to Rule 144 for the purposes of the volume limitations of Rule 144(e).

-[36]- Exchange Act Release No. 37801 (Oct. 10, 1996) (61 FR 54506 (Oct. 18, 1996)).

-[37]- The Commission is not, however, amending Item 701 of Regulation S-K (17 CFR 229.701) and Regulation S-B (17 CFR 228.701) to remove the reference to Form 8-K as proposed. To the extent an issuer chooses voluntarily to report an unregistered sale of securities on Form 8-K, in addition to Forms 10-Q, 10-QSB, 10-K or 10-KSB, the information required by Item 701 must be provided.

-[38]- 15 U.S.C. 78w(a).

-[39]- 15 U.S.C. 77b.

-[40]- 15 U.S.C. 78c.

-[41]- Pub. L. No. 104-290, 106, 110 Stat. 3416 (1996).

-[42]- The finding required by Section 23(a) of the Exchange Act only relates to amendments under the Exchange Act, such as amendments to Forms 8-K and 10-Q, and not to amendments under the Securities Act. In general, the Exchange Act amendments, by easing the Form 8-K reporting requirements, should not affect competition.

Continue to V.  COST-BENEFIT ANALYSIS

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