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SEC - Regulation S

Regulation S is a safe harbor that occurs when an offering of securities is deemed to come to rest abroad so as not to be subject to registration imposed under Section 5 of the Securities Act. Section 5 includes offers and sales that occur within the United States and do not include offers and sales that occur outside the United States. Regulation S includes several safe harbor exemptions for specified transactions.


Each safe harbor is subject to two general conditions:


1. The offer or sale must occur in an “offshore transaction" and the seller must have reason to believe that the buyer is offshore at the time of the offer or sale, or the transaction must occur on certain “designated offshore securities markets" while the transaction is not pre-arranged with a buyer in the United States.


2. No directed selling efforts may be made in the U.S. by the issuer, a distributor, or any of their respective affiliates, including efforts reasonably expected to condition the U.S. market for the securities.


3. In addition, Rule 903 provides three categories for offerings by issuers, distributors and their respective affiliates.


Category 1


(a) securities of a “foreign issuer” for which there is no “substantial U.S. market interest”
(b) securities offered by a “foreign issuer” in “overseas directed offerings”
(c) non-convertible debt securities of a domestic issuer offered in overseas directed offerings that are denominated in a currency other than U.S. dollars
(d) securities backed by the full faith and credit of a foreign government.

In these cases, only the two general conditions referred to above must be observed.


Category 2:


(a) equity offerings by reporting foreign issuers; and
(b) offerings of debt securities and non-convertible, non-participating preferred stock by reporting issuers or non-reporting foreign issuers.


To be treated as a qualified reporting issuer, the issuer must have filed all required reports for at least twelve months prior to the offer or sale, or such shorter period during which the issuer was subject to the reporting obligation.


Offering restrictions include prohibitions on re-sales to U.S. Persons during the distribution compliance period, in addition to the application of the two general conditions. Generally, a 40-day distribution compliance period obtains.


A safe harbor exemption is an exemption that is not the exclusive means that must be employed to fall within a more general exemption or jurisdictional limitation. By providing a safe harbor, the SEC is affirming that someone complying with its requirements will have the benefit of the broader exemption.


Category 2 offerings have to be memorialized in a written agreement with each distributor and reflected in the offering documentation and on all confirmations issued to distributors and others receiving transaction-based compensation and to purchasers during the distribution compliance period.


Category 3 offerings are all other securities, including:


(a) equity offerings by domestic reporting issuers;
(b) offerings of equity securities by non-reporting foreign issuers for which there is a substantial U.S. market interest; and,
(c) offerings by U.S. issuers that are not reporting issuers.


Category 3 offerings are subject to the more stringent conditions than the other two categories.


For debt securities the offering restrictions are the same as for Category 2, plus the need to use a temporary global certificate to support the 40-day distribution compliance period.


For equity securities, the distribution compliance period is increased to one year, and the purchaser must also provide a certification as to its non-U.S status and must agree not to resell to a U.S. Person except in accordance with U.S. requirements, in addition to compliance with the restrictions applicable to Category 2.


The securities of a domestic issuer must bear a restrictive legend, supported by stop transfer instructions. The documentation required in the case of such issuers must refer to the prohibition on certain hedging transactions during the distribution compliance period that would have the effect of pre-selling, the securities into the United States and distributors must agree in writing to observe this prohibition.


Rule 904 provides a safe harbor for certain resale transactions by persons other than the issuer, a distributor, any of their affiliates (except any officer or director who is an affiliate solely by virtue of such office), or any person acting on their behalf. Re-sales are subject to the following conditions:


1. All permitted sellers are subject to the general conditions.
2. In the case of a seller who is a dealer or a person receiving any remuneration, a resale cannot be knowingly made to a U.S. Person prior to the end of the relevant distribution compliance period. A confirmation stating the applicable securities law restrictions must be sent to any other dealer or person receiving selling compensation person.
3. No special compensation can be paid if the seller is an officer or director of the issuer.
4. The safe harbor is not available to affiliates of the issuer, except where affiliation arises solely from the status of the seller as an officer or director.


An “affiliate” is any person controlling, controlled by or under common control with the issuer. “Control” for this purpose means de facto control. An automatic inference of control based upon voting influence arises at the 10% threshold, although other factors may point away from control and exceptions are made.


5. Transactions must be effected through a “designated offshore securities market” in a transaction not pre-arranged with a U.S. Person or in a transaction involving a buyer outside of the United States at the time the buy order is originated.


6. Care must be taken to ensure that the transaction does not involve a scheme to evade the Securities Act registration requirements, including for the purpose of washing off transfer restrictions.


Rule 905 provides that equity securities of domestic issuers acquired from the issuer, distributor, or any of their respective affiliates in a transaction subject to the safe harbor rules are deemed to be restricted securities, and re-sales by any offshore purchaser must be made pursuant to the Regulation or another exemption from Securities Act registration.


The following definitions obtain:


1. “U.S. Person” For individuals, based largely on residence, rather than nationality. Entities have residence largely based upon where they are formed, with the exception of identifiable branches of entities, which may themselves be treated as the equivalent of separate organizations.


2. Accredited investors can form an offshore entity that will be treated as a non-U.S. Person for this purpose. Detailed rules govern trusts and estates, and other professional fiduciaries, which are designed to mitigate disadvantages to U.S. professional fiduciaries by ensuing that, subject to certain conditions, offers to them for the account of non-U.S. Persons will not trigger Securities Act registration, despite the making of an offer to the fiduciary in the United States.


3. “Substantial U.S. Market Interest” or “SUSMI”: This applies to equity securities if: (i) U.S. securities exchanges and NASDAQ in the aggregate constituted the single largest market for such class of securities in the issuer’s prior fiscal year, or (ii) 20% or more of trading in the class of equity securities during such period occurred in such U.S. markets and less than 55% of trading in such securities took place during that period through the facilities of the securities markets or a single foreign country. Separate SUSMI 

rules apply in the case of debt securities.


4. A “foreign issuer” is a foreign-organized entity other than such an entity that has more than 50 percent of its voting securities being held by U.S. residents and either:
(i) the business of the company is administered principally in the U.S.; (ii) 50 percent or more of its directors or executive officers are U.S. residents; or, (iii) more than 50% of its assets are located in the U.S.


5. An “Overseas Directed Offering” by a foreign issuer “directed into a single country other than the United States to the residents thereof .in accordance with the local laws and customary practices and documentation of such country.


6. “Offering Restrictions"


Offering restrictions require each distributor to agree in writing that all offers and sales of the securities prior to the expiration of the distribution compliance period shall be made only (i) in accordance with the provisions of the applicable safe harbors, (ii) pursuant to registration of the securities under the Securities Act, or (iii) pursuant to an available exemption from the registration requirements of the Securities Act; and, (iv) for offers and sales of equity securities of domestic issuers not to engage in prohibited hedging transactions prior to the end of the distribution compliance period.


The offering restrictions also require that all offering documents other than press releases used in connection with offers of the securities prior to the expiration of the distribution compliance period include statements to the effect that the securities have not been registered under the Securities Act and may not be offered or sold in the United States or to U.S. Persons(other than distributors)--unless the securities are registered or an exemption from the registration requirements of the Securities Act is available, and, in the case of equity offerings by domestic issuers, statements concerning the hedging prohibition.


Such statements should appear (i) on the cover or inside cover page of any prospectus or offering circular used in connection with the offer or sale of the securities; ii) in the underwriting section of any prospectus or offering circular used in connection with the offer or sale of the securities; and, (iii) in any advertisement made or issued by the issuer, any distributor, any of their respective affiliates, or any person acting on behalf of any of the foregoing. Such statements may appear in a summary form on prospectus cover pages and in advertisements.


Broker-dealers must confirm that they are not unlawfully effecting distributions of Canadian securities in the United States in violation of Regulation Sand other U.S. securities law requirements. This may result, for example, from purchases of small cap issues by foreign accounts from the issuer, a promoter or affiliated entities ostensibly using Regulation S or some other exemption for resale into the United States for the purpose of effecting a distribution. Such transactions may be found to violate the registration requirements of the Securities Act and have severe consequences.

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Our monthly reporting service, Exempt Offerings Reporter, summarizes recent developments in the world of Blue Sky law and regulation. 

To get started or just to ask questions, email dslain@privateplacementadvisors.comDouglas Slain can be reached directly at 415-317-6130.