Reg S: The Beauty and the Beast of Foreign Securities Sales

Guarding our capital markets and protecting American investors from fraud, the US Securities and Exchange Commission (“SEC”) regulates both foreign and domestic issuers that engage in the sale and distribution of securities in the United States. 

Without getting into the weeds about whether the SEC actually has jurisdiction over foreign issuers selling foreign shares outside the United States (1) , it is prudent to discuss the regulatory interests espoused by Regulation S.

Regulation S provides an exemption from the costly and burdensome registration of securities for foreign sale of securities.  Normally, an issuer bears the cost of the thorough review of all related securities promotional materials and registration documents by the SEC before sale of securities to foreign investors by both domestic and foreign issuers.

Rule 903 of Regulation S is the safe harbor that provides three categories of transactions that are exempt from federal registration. The exemption applies if 

(1) there is an offshore transaction, (2)

(2) no directed selling efforts (3) are made in the United States by the issuer, among 

(3) other conditions that need to be satisfied as stated in the Categories: 

Category 1 [Applies to Foreign Issuers]: 

Offering of securities issued by a foreign issuer may be exempt if:

(1) There is a reasonable belief that there is no substantial market interest (4) in the US in securities or debt securities being sold. 

(2) Securities are offered and sold in an overseas directed offering. 

(3) Securities are backed by the full faith and credit of a foreign government. 

(4) Securities are offered and sold to employees of the issuer pursuant to an employee benefit plan established by foreign law. 

Examples for Category 1: 

• A publicly traded Australian company with 90% of its trading volume in the Asia-Pacific region issues an additional public offering on the Australian Stock Exchange. (5)
• A Japanese Company offers and sells stock to Japanese residents in Japan. 
• The German Government auctions its government Bundesanleihe bonds.
• A Canadian Company issues stock options to its employees pursuant to an employee benefit plan established under Canadian law.  

Category 2 [Applies to Equity Securities of a Reporting Foreign Issuer; Debt securities of a Reporting Foreign & Domestic Issuer or Non-reporting foreign Issuer]:  

For an issuer that does not fit into Category 1, we rely on Category 2:

(1) Securities issued by a foreign issuer, with certain offering restrictions in place to prevent a U.S. person from acquiring those securities. 

(2) Distribution compliance period of 40 day – prevents securities from being brought back into the United States and redistributed to a US person for 40 days. 

(3) Any distributor or dealer complies with the distribution compliance period.  

Example for Category 2: 

• A publicly traded Finnish company that has filed registration statements with the SEC offers its stock to an institutional investor in Europe. The securities offered cannot be sold by that Euro investor to a US person or into the United States for at least 40 days. 

Category 3 [Applies to Domestic & Foreign Issuers]:

An issuer that does not fit into Category 1 or 2, will rely on Category 3. This applies to both domestic and foreign issuers: 

(1) There is a 40-day restriction on sales or offer of bonds, during the “distribution compliance” period.

(2) For stock: 

(A) There is a one-year distribution compliance period for non-reporting issuers.

(B) There is a 6-month distribution for a reporting issuer. 

(C) Certification that purchaser is not a US person nor acquiring for the benefit of one. 

(D) Contractual obligation binding the purchaser of the security only to resell them, pursuant to the provisions of Regulation S. 

(E) For domestic issuers, a “legend” disclaimer, indicating that those securities were sold pursuant to Reg S.

(F) Issuer is contractually bound not to register any shares offered pursuant to Reg S.

(G) Any distributor or dealer will also comply with restricted “distribution compliance” periods. 

Example for Category 3: 

• A privately held Wyoming company offers stock solely to Argentinian investors, pursuant to Category 3.  The proceeds will be deployed in the USA on behalf of those Argentinian stakeholders. 

Issuers relying on Reg S generally cannot use directed selling efforts on America soil, “undertaken for the purpose of, conditioning the market,” and cannot advertise in the United States. The regulators want to make sure that the securities being offered by issuers are truly made offshore and will not “flowback” to the US Market. 

There remain five important caveats: 

1. Absent a specific state registration exemption, domestic issuers may still be subject to state Blue-Sky Law registration requirements. (6)
2. Even though foreign issuers are likely outside the jurisdiction of state regulators, they may be subject to the laws of a foreign jurisdiction for sale of securities in that jurisdiction and should consult the appropriate foreign counsel on that matter.
3. Regulation S specifically allows an issuer not to register securities that are unintended for sale to US citizens but does not necessarily exempt that issuer from all other securities laws,  nor does Reg S insulate domestic or foreign issuers from the jurisdictional reach of the SEC. The Dodd-Frank Act expands the jurisdictional reach of federal securities law (including the SEC by corollary) through the amendment of the Securities Act of 1933 § 22. (7)
4. Rule 144 is still applicable to the Reg S transactions that fall within the definition of “restricted securities” under Rule 144(a).
5. Additionally, Regulation S does not apply to Investment Companies that are subject to the registration requirements under the Investment Company Act of 1940.

While Regulation S offers both domestic and foreign issuers some flexibility when offering securities overseas, acute attention must be paid to rule requirements in order to avoid any regulatory landmines that could arise from an unregistered stock or bond sale.  

A parting word of caution: I strongly dissuade clients from receiving funds from any persons who originate from countries that are presently sanctioned by the United States.

1.  The Supreme Court ruled in Morrison v. Nat’l Australia Bank Ltd. that Federal Securities laws only apply to the United States unless Congress stated otherwise.  561 U.S. 247 (2010). But in Sec. & Exch. Comm’n v. Scoville, the 10th Circuit upheld a District Court’s holding that the § 17(a) [antifraud provision] of the Securities Act could apply to foreign transactions if it has “foreseeable substantial impact on the United States.” 913 F.3d 1204, 1210 (10th Cir.), cert. denied, 140 S. Ct. 483, 205 L. Ed. 2d 268 (2019) (citing § 22(c)). 
2.  Offshore transactions are defined under 902(h) as transactions not made to a person in the US and either (1) occurred outside the US, or (2) in a foreign securities exchange.
3.  Defined broadly to mean “any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States.”
4.  Substantial U.S. Market Interest is defined in Rule 902(j) and is measured by the volume of trades of the particular security that has occurred in the United States. 
5. With the assumption that the company has no SEC reporting requirements pursuant to Rule 13a-1, 13a-16, and 15d-16.
6. See e.g. § 202 of the Uniform Securities Act (2005), as amended. 
7. For further discussion on the matter See Sec. & Exch. Comm’n v. Scoville, 913 F.3d 1204, 1224 (10th Cir.), cert. denied, 140 S. Ct. 483, 205 L. Ed. 2d 268 (2019).