I. Background
Rules 903 and 904 of Regulation S set forth two non-exclusive safe-harbors for offers and sales that are deemed to occur outside the United States. Rule 903 applies to offers or sales of securities by issuers, distributors and any of their respective affiliates. Rule 903, as amended, distinguishes among three categories of securities offerings:
- Category 1 applies to certain foreign issuers; overseas directed offerings; securities backed by the full faith and credit of a foreign government; and employee benefit plan securities.
- Category 2 applies to securities that are not eligible for Category 1 and that are equity securities of a reporting foreign issuer or debt securities of a reporting domestic issuer or of a non-reporting foreign issuer.
- Category 3 applies to securities that are not eligible for Category 1 or Category 2, including equity securities of either a reporting or non-reporting domestic issuer. The effect of the amendments is to recategorize equity securities of domestic reporting issuers from Category 2 to Category 3.
Rule 904 applies to resales of securities by any person other than the issuer, a distributor or any of their respective affiliates (except any officer or director who is an affiliate solely by virtue of holding such position).
II. The Adopting Release - Summary
The principal amendments contained in the Adopting Release are as follows:
(ii) equity securities of domestic issuers sold offshore under Regulation S are now classified as "restricted securities" within the meaning of Rule 144 under the Securities Act ("Rule 144"), so that resales without registration or an exemption from registration will be limited;
(iii) offshore resales under Rule 904 of equity securities of domestic issuers that are "restricted securities" will not affect the restricted status of such securities;
(iv) the certification, legending and other requirements currently applicable to sales of equity securities by non-reporting issuers, will now also be imposed on sales of equity securities of reporting domestic issuers; and
(v) in order to alert purchasers of equity securities of domestic issuers to potential restrictions on hedging their positions in such securities, purchasers will have to agree to conduct hedging transactions with respect to the securities in compliance with the Securities Act, including Rule 144 thereunder.
Extension of the Distribution Compliance Period. To avoid confusion between the holding period for "restricted securities" under Rule 144 and the "restricted period" under Regulation S, the term "restricted period" in Regulation S has been changed to the "distribution compliance period". The distribution compliance period for equity securities of reporting domestic issuers sold pursuant to Regulation S has been lengthened from 40 days to one year to coincide with the holding period for equity securities of all other Category 3 issuers and with the period when limited resales may begin under Rule 144.
Offering Restrictions. "Offering restrictions" currently applicable to sales of equity securities by domestic issuers under Regulation S (such as agreements by distributors that 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) must be revised to reflect the new one-year distribution compliance period applicable to these offerings.
In addition, the amendments require that, in the case of offers or sales of equity securities of domestic issuers made pursuant to Regulation S, additional language must be provided in mandated agreements and in a legend on the securities themselves to the effect that hedging transactions not in compliance with the Securities Act are prohibited.
Purchaser Agreements and Certifications. Offerings of Category 3 securities are subject to certain certification, legending and other requirements, which, prior to the effective date of the amendments, are applicable only to sales of equity securities by non-reporting issuers. Such requirements will now be applicable to sales of equity securities of all domestic issuers offered pursuant to Regulation S, including those of reporting issuers. Such requirements include:
(ii) agreement by each purchaser to resell such securities only in accordance with Regulation S or pursuant to registration or an available exemption therefrom under the Securities Act;
(iii) legending the securities to the effect that transfer is prohibited except in accordance with the provisions of Regulation S or pursuant to registration or an available exemption therefrom under the Securities Act; and
(iv) refusal by the issuer, either by contract or a provision in the issuer's charter documents, to register any transfer of its securities not made in compliance with Regulation S or pursuant to registration or an available exemption therefrom under the Securities Act.
Restricted Securities. Under new Rule 905 equity securities placed offshore by domestic issuers under Regulation S will be classified as "restricted securities" within the meaning of Rule 144, so that resales of such securities without registration or an exemption from registration will be restricted as provided therein. The SEC will continue to monitor practices among foreign issuers and could reexamine its position not to classify such securities as "restricted securities" at a later date.
These new restrictions apply to all "equity securities" of domestic issuers, including stock, securities convertible or exchangeable into stock (including convertible debt securities), warrants, options, rights to purchase stock and other types of equity-related securities (without regard to the conversion or exercise premium or other factors) but do not apply to straight debt securities, non participating preferred stock or asset-backed securities.
Resales. 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.
Retroactive Application. Rule 905 does not apply retroactively to classify domestic equity securities sold under Regulation S prior to the effective date of the amendments as restricted securities under Rule 144. However, the SEC's position that the resale offshore of domestic equity securities that are restricted securities does not "wash off" resale restrictions will apply to offshore sales taking place before the effective date of the Adopting Release.
Application to Employee Benefit Plans. Equity securities of domestic issuers offered and sold to non-U.S. resident employees through an employee benefit plan governed by foreign law, heretofore not subject to a distribution compliance period, will now be treated as restricted securities, subject to the Rule 144 resale restrictions. Such securities can, however, be easily registered on Form S-8.
V.Special Rules for Promissory Notes Used to Fund Restricted Security Purchases
The SEC has been concerned that Regulation S has been abused through the use of promissory notes as consideration for securities purchased in Regulation S transactions. These promissory notes of the purchaser were often repaid only upon resale of the purchased securities into the U.S. market. To address this problem, the amendments toll the holding period under Rule 144 unless the promissory note provides for full recourse against the purchaser 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 must be paid in full before resale of the securities is permitted under Rule 144.
VI. Reporting of Regulation S Transactions
Currently, sales of equity securities of domestic issuers under Regulation S are required to be reported on Form 8-K within 15 days of occurrence. Effective January 1, 1999, the Form 8-K reporting requirement will be eliminated and such sales will be required to be reported quarterly on Forms 10-Q, 10-QSB, 10-K or 10-KSB, as applicable.