[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. 

[[Page 35664]]

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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 

[[Page 35665]]
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