United States: SEC Staff Issues Guidance Regarding 144A And Regulation S

On December 8, 2016, the staff of the Securities and Exchange Commission (SEC) issued new Compliance and Disclosure Interpretations (C&DIs) to provide guidance regarding status of qualified institutional buyers (QIBs) under Rule 144A of the Securities Act of 1933, as amended (Securities Act). Rule 144A provides a safe harbor exemption from the registration requirements of Section 5 of the Securities Act of 1933, as amended (Securities Act) for certain offers and sales of qualifying securities by persons other than the issuer of the securities. Specifically, the exemption applies to resales of securities to QIBs. The C&DIs released on December 8, 2016 also provided guidance relating to offerings made in reliance on Regulation S, which provides a safe harbor from the registration requirements of Section 5 of the Securities Act for certain offshore transactions where no directed selling efforts are being made in the United States.

Calculating $100 Million Threshold under Rule 144A

Rule 144A(a)(1)(i) defines a QIB by listing several types of entities that, acting for their own account or the accounts of other QIBs, own and invest on a discretionary basis at least $100 million in securities of non-affiliate issuers in the aggregate. In its latest C&DIs, the SEC staff clarifies what securities are included for the purposes of calculating the $100 million threshold.

According to the SEC staff, when calculating the $100 million threshold under Rule 144A(a)(i), an entity may include:

  • securities that the issuer has purchased and continued to hold on margin (so long as they are not subject to a repurchase agreement) (C&DI 138.05); and
  • securities that the entity owns but has loaned out to borrowers (C&DI 138.06);

However, when calculating the $100 million threshold under Rule 144A(a)(i), an entity may not include:

  • securities that it has borrowed (C&DI 138.07); or
  • short positions in securities that it has established (C&DI 138.08).

Also, for an investment company that is not registered under the Investment Company Act of 1940, it may not aggregate investments by other funds that may be part of the non-registered investment company's family of funds in the manner described under Rule 144A(a)(1)(iv). According to the SEC staff, only registered investment companies may use the aggregation method permitted under Rule 144A(1)(iv). (C&DI 138.09)

Finally, when determining its status as a QIB under Rule 144A, Rule 144A(a)(1)(v) provides that an entity will be deemed a QIB if all of its equity owners are QIBs. According to the SEC Staff, when the entity is a limited partnership, the limited partners are the equity owners. The general partner does not need to be considered in determining whether a limited partnership is a QIB so long as the QIB is not also a limited partner. (C&DI 138.10)

Regulation S

Regulation S, which was promulgated under the Securities Act, provides a safe harbor for certain types of public and private offerings by both U.S. and foreign issuers that are made outside of the U.S. so that they are not required to be registered under Section 5 of the Securities Act. In general, in order to rely on Regulation S, offers and sales must be made in an "offshore transaction" and there cannot be any "directed selling efforts" with respect to the securities (e.g., activities that could be expected to condition the market in the U.S. for any of the securities being offered in an offering relying on the Regulation S safe harbor).

Definition of U.S. Person

Whether the Regulation S conditions are met depends in part on the definition of "U.S. persons," which is defined in Rule 902(k)(1) of Regulation S. Any natural person resident in the United States is a U.S. person according to Rule 902(k)(1)(i) of Regulation S. In C&DI 276.01, the SEC staff clarified that a person that has permanent resident status in the U.S. (a so-called Green Card holder) is presumed to be a U.S. resident for purposes of Regulation S. However, if a person is not a Green Card holder, the SEC staff indicates that an issuer must decide what criteria it will use to determine residency and apply such factors consistently without changing them to achieve a desired result. Examples of such factors would include, according to the SEC staff, tax residency, nationality, mailing address, physical presence, the location of a significant portion of an individual's financial and legal relationships, or immigration status.

The European Union May be a "Single Country" for Purposes of Category 1 Transactions

Rule 903 of Regulation S distinguishes among three categories of transactions based on the type of securities being offered, whether the issuer is domestic or foreign, whether the issuer is a reporting issuer under the Securities Exchange Act of 1934, as amended, and whether there is "substantial U.S. market interest" in the securities being offered. Category 1 transactions are those where the securities being offered are least likely to enter the U.S. The only restrictions here are that the transaction is made in an "offshore transaction" and that there are no "directed selling efforts" in the U.S. One type of offering that is eligible to qualify as a Category 1 transaction is "[a]n offering of securities of a foreign issuer that is directed into a single country other than the United States to the residents thereof that is made in accordance with the local laws and customary practices and documentation of such country." See Rule 903(b)(1)(ii)(A) of Regulation S.

The SEC staff confirmed that an issuer may rely on Rule 903(b)(1)(ii) of Regulation S for an offering of securities in more than one country that is part of the European Union (C&DI 277.02). As the SEC Staff pointed out in C&DI 277.02, Regulation S was adopted before the integration of the capital markets within the European Union. Given the level of integration resulting from the application of EU-wide laws and regulations relating to prospectuses, transparency, trading and other matters, the SEC Staff takes the position that issuers may rely on Rule 903(b)(1)(ii) to the extent that the local laws and customary practices and documentation are those of the European Union (as opposed to those of a single country within the European Union).

Also, for the reasons discussed above, the SEC staff confirmed that an issuer may rely on Rule 903(b)(1)(iv)—which allows certain securities offered to employees to be considered Category 1 transactions under Regulation S—for an offering of securities to employees if the laws, customary practices and documentation are those of the European Union rather just a "single" country other than the U.S. (C&DI 277.03).

Relying on Category 2 Guidance for Category 3 Transactions

The SEC staff confirmed that issuers conducting Category 3 transactions can rely on Category 2 guidance to establish that an offer and sale is not made to a U.S. person or for the account or benefit of a U.S. person (C&DI 277.04). In adopting Regulation S, the SEC stated that persons relying on the second issuer safe harbor (now referred to as Category 2) must "ensure (by whatever means they choose) that any non-distributor to whom they sell securities is a non-U.S. person and is not purchasing for the account or benefit of a U.S. person." In Securities Act Release No. 6863 (April 24, 1990), the SEC noted that the "safe harbor protection would not be available where offers and sales were made nominally to non-U.S. persons to evade the restrictions." In C&DI 277.04, the SEC Staff confirmed the applicability of this guidance to Category 3 transactions.

Electronic Certifications and Agreements Permitted

Regulation S requires certain certifications and agreements to be made in order to comply with its conditions. For instance, a Category 3 transaction requires that the purchaser make certain certifications and make certain agreements with respect to the reselling of the offered securities. Also, an offer or sale of warrants under Category 2 or 3 transactions requires each person exercising a warrant to give certain written certifications with respect to such person's status as a U.S. person. The SEC Staff confirmed that such certifications and agreements can be made electronically (C&DI 277.05). Any electronic procedures used by issuers and distributors to obtain such certifications and agreements may be implemented by third parties. Furthermore, according to the SEC staff, issuers and distributors may rely on electronic procedures to the same extent and in the same manner as when certifications and agreements are obtained in paper.

Applicability of Rule 903(b)(4) when Parent of Issuer is Guarantor of Debt Securities

Rule 903(b)(4) of Regulation S provides that in offerings of debt securities fully and unconditionally guaranteed as to principal and interest by the parent of the issuer of the debt securities, only the requirements of Rule 903(b) that apply to the offer and sale of the guarantee must be satisfied with respect to the offer and sale of the guaranteed debt securities. The SEC staff clarified that Rule 903(b)(4) also applies to offerings of debt securities that are guaranteed by subsidiaries of a parent company guarantor or parent company issuer (C&DI 277.06).  Accordingly, when the parent company is the issuer (or co-issuer) of debt securities and one or more subsidiaries is a guarantor or when the parent company is a guarantor and there are one or more subsidiaries that are also guarantors, as long as the payment obligation of the parent company is full and unconditional, then, in each case, Rule 903(b)(4) applies.

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