The staff of the Division of Corporation Finance of the Securities and Exchange Commission (the SEC) recently issued interpretations of the definition of a “qualified institutional buyer” for purposes of the safe harbor contained in Rule 144A. The staff also addressed certain issues relating to offshore offerings and resale transactions under Regulation S.
Separately, the staff issued interpretations clarifying various aspects of the definition of a “foreign private issuer” for US securities law purposes, which are discussed in our memorandum located here.
Interpretations relating to determination of “qualified institutional buyer” status for transactions under Rule 144A
Rule 144A provides a safe harbor from the registration requirements of the Securities Act of 1933, as amended (the Securities Act), for resales of securities not fungible with securities listed on a US securities exchange to qualified institutional buyers. “Qualified institutional buyer” status is available to, among others, insurance companies, registered investment companies, registered investment advisers, employee benefit plans, business development companies, corporations and partnerships that own and invest on a discretionary basis at least $100m in securities of unaffiliated issuers.
The staff interpretations provide the following guidance with respect to determination of “qualified institutional buyer” status under Rule 144A.
Treatment of loaned or borrowed securities. The staff has confirmed that securities that the entity owns but has loaned out to borrowers may be included in calculating the $100m threshold for determining the entity’s qualified institutional buyer status. By contrast, since borrowed securities are not owned by the borrower, they should not be taken into account in calculating whether the $100m threshold is met.
Treatment of securities held on margin. The staff has clarified that an entity may include securities that it purchased and continues to hold on margin in determining whether the entity meets the $100m threshold, as long as such securities are not subject to a repurchase agreement.
Treatment of short positions in securities. Because short positions represent sales rather than ownership of securities, they should not be included in calculating whether the $100m threshold of the qualified institutional buyer definition is met.
Treatment of limited partnerships. An entity will be deemed a qualified institutional buyer if all of its equity owners are qualified institutional buyers. The staff has clarified that, in determining their qualified institutional buyer status under this rule, limited partnerships should look at the status of their limited partners, who are considered equity owners of a partnership for purposes of this rule. Unless the general partner is also a limited partner, its status need not be considered in determining whether the partnership is a qualified institutional buyer.
Treatment of unregistered investment companies. Rule 144(a)(1)(iv) allows two or more investment companies registered under the Investment Company Act of 1940, that have the same investment adviser, to aggregate their investments in securities of unaffiliated issuers for the purposes of the $100m threshold. The staff has confirmed that the aggregation method permitted by this rule is available only to registered investment companies and does not apply to investment companies that are not registered under the Investment Company Act.
Interpretations relating to various aspects of Regulation S offerings
Regulation S provides a safe harbor from the registration requirements of the Securities Act for offerings made outside the United States if the following two basic conditions and the requirements applicable to the relevant transaction “category” are satisfied:
the offer or sale is made in an “offshore transaction” (which requires, among other things, that the offer is not made to a person in the United States); and
there are no “directed selling efforts” in the United States with respect to the securities offered under Regulation S.
There are three categories of transactions under Regulation S. Category 1, which has no additional requirements, applies if (1) the securities are issued by a foreign issuer that reasonably believes that there is no substantial US market interest in its equity securities (if equity is to be issued), debt securities (if debt is to be issued), securities issuable upon exercise (if warrants are to be issued) and convertible securities or underlying securities (if convertible securities are to be issued), (2) the securities are directed by a foreign issuer 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, (3) a US domestic issuer directs non-convertible debt securities into a single country other than the United States to the residents thereof in compliance with the local laws and customary practices and documentation of such country and the principal and interest of such debt securities are denominated in a currency other than US dollars, (4) the securities are backed by the full faith and credit of a foreign government, or (5) the securities are offered to employees of the issuer or its affiliates pursuant to an employee benefit plan established and administered in accordance with the laws of a country other than the United States and customary practices and documentation of such country.
Category 2 applies to securities that are not eligible for Category 1, are equity securities of a reporting foreign issuer, or debt securities of a reporting issuer or of a non-reporting foreign issuer. For Category 2 offerings, among other things, certain offering restrictions are required to be implemented, and the offer or sale, if made prior to the expiration of a 40-day distribution compliance period, cannot be made to a US person.
Category 3 applies to all other offerings and requires, among other things, implementation of certain offering restrictions, a 40-day distribution compliance period during which offers cannot be made to a US person (for debt securities) and a one-year (or six-month if the issuer is a reporting company) distribution compliance period during which offers cannot be made to a US person (for equity securities).
Regulation S also provides a registration exemption for offshore resales if (1) the offer or sale is made in an offshore transaction, (2) no directed selling efforts are made in the United States, (3) for dealers, during the distribution compliance period specified in Category 2 or 3 as applicable, the seller does not know that the offeree or buyer is a US person, and (4) for offers by an officer or director of the issuer or a distributor, who is an affiliate of the issuer or distributor solely by virtue of such position, no selling concession, fee or other remuneration is paid in connection with such offer or sale other than the usual and customary broker’s commission.
The new staff interpretations provide the following guidance with respect to Regulation S offerings.
Determination of who is a “natural person resident in the United States” for purposes of the “US person” definition in Regulation S. As described above, whether the conditions of Regulation S are met depends in part on whether offers and sales are made to a “US person,” which includes, among other categories, a “natural person resident in the United States.” The staff has clarified that, while a person who has permanent resident status in the United States (a green card holder) is presumed to be a US resident, individuals without permanent resident status may also be US residents for purposes of the above definition, based on such factors as (i) tax residency, (ii) nationality, (iii) mailing address, (iv) physical presence, (v) the location of a significant portion of their financial and legal relationships, or (vi) immigration status. Issuers will need to decide what criteria they will use to determine residency and apply them consistently without changing the criteria to achieve a desired result.
In a separate set of interpretations, for purposes of determining a company’s status as a “foreign private issuer,” the staff clarified that the same factors should be applied to determine whether more than 50 percent of a foreign company’s outstanding voting securities are owned by “US residents.”
Treatment of the European Union as a single country for Category 1 offerings. As described above, certain offerings qualify as a Category 1 offering if the securities are directed to the residents of a single country other than the United States and the offering is made in accordance with the local laws, customary practices and documentation of such country. The staff has clarified that this requirement will be satisfied if an offering is directed into more than one country that is part of the European Union. Given the integration of the capital markets within the European Union as a result of the application of EU-wide laws and regulations, an offering will constitute a Category 1 offering to the extent the local laws and customary practices and documentation are those of the European Union (as opposed to those of a single EU member state).
For the same reasons, securities offerings made pursuant to employee benefit plans may be considered Category 1 transactions if they are done in accordance with the law, customary practices and documentation of the European Union.
Application of certain Category 2 guidance to Category 3 offerings. Category 2 offerings are subject to a 40-day distribution compliance period, during which no offers or sales may be made to a US person or for the account or benefit of a US person. In adopting Regulation S, the SEC indicated that persons relying on the Category 2 safe harbor must “ensure (by whatever means they choose) that any non-distributor to whom they sell securities is a non-US person and is not purchasing for the account or benefit of a US person.” The SEC also noted that the “safe harbor protection would not be available where offers and sales were made nominally to non-US persons to evade the restrictions.” (Securities Act Release No. 6863 (April 24, 1990)).The staff has confirmed that issuers seeking to rely on the Category 3 safe harbor may follow this guidance in establishing that offers and sales are not made to a US person or for the account or benefit of a US person during the applicable Category 3 distribution compliance period (40 days for nonconvertible debt securities, six months for equity securities of a reporting issuer, and one year for equity securities of a non-reporting issuer).
Electronic certifications and agreements for Regulation S purposes. In a number of cases, certain certifications and agreements are required for an offering to benefit from a particular Regulation S safe harbor. For example, in a Category 3 debt offering, persons (other than distributors) must provide a certification of beneficial ownership for the debt securities that are represented by a temporary global note to be exchanged for definitive securities. Also, in an offer or sale of warrants under Category 2 or 3, a person exercising a warrant may need to provide a written certification that it is not a US person and the warrant is not being exercised on behalf of a US person. In the absence of specific requirements relating to the manner in which such certifications and agreements must be made, the staff has confirmed that they may be made electronically. Any electronic procedures for obtaining certifications and agreements may be implemented by third parties, and issuers and distributors are permitted to rely on those procedures to the same extent and in the same manner as when certifications and agreements are obtained in paper form.
Interpretation with respect to offerings of guaranteed debt securities. Regulation S provides that, if an offering of debt securities is fully and unconditionally guaranteed by the issuer’s parent, only the requirements of Rule 903(b) that are applicable to the offer and sale of the guarantee must be satisfied with respect to the offer and sale of the guaranteed debt securities. The staff has confirmed that this rule also applies to offerings where (i) the parent company is the issuer (or a co-issuer) of the debt securities and one or more of its subsidiaries is a guarantor, or (ii) the parent company is a guarantor and there are one or more subsidiaries which are also guarantors of the securities, in each case provided that the payment obligation of the parent company is full and unconditional.
The authors wish to thank Evgeniya Berezkina for her assistance in the preparation of this client alert.