Regulation S (Reg S)

What is Regulation S?

Regulation S, within the framework of the Securities Act of 1933, provides a mechanism for both U.S. and non-U.S. entities to raise capital for foreign companies while remaining compliant with U.S. federal securities laws. This exemption encompasses various financial instruments, including debt securities and equity securities, allowing the issuance of convertible securities as part of a capital-raising transaction.

Under Reg S, issuers can conduct offerings outside the United States without the need for securities registration, subject to certain conditions. These conditions involve directed selling efforts, compliance with local laws, and adherence to federal securities laws. The Regulation S exemption also addresses the transfer of securities, permitting the register securities transfers for securities sold during an overseas directed offering.

The regulation is particularly beneficial for raising capital beyond U.S. borders, enabling the issuance of dollar-denominated securities. It exempts offerings involving unit investment trusts, including those registered under the Investment Company Act. Furthermore, it acknowledges the presence of U.S. persons and provides exemptions for certain categories, such as accredited investors.

How does Regulation S work for international securities?

Regulation S operates on the principle of extraterritoriality, providing a framework for the offer and sale of securities outside the United States in good faith. It is crucial to note that Regulation S cannot be utilized to circumvent the registration requirements imposed by the Securities and Exchange Commission (SEC). To qualify for non-registration under Regulation S, an offering must satisfy two primary criteria:

1. The offer or sale must be executed in an offshore transaction. In other words, it should involve a foreign entity located outside the U.S. or a transaction conducted on a securities exchange or market located outside the U.S.

2. The issuer or any person acting on their behalf must not engage in directed selling efforts. This implies that there should be no activities aimed at conditioning the market in the U.S. for the offered securities.

Various types of Regulation S offerings can be conducted by both U.S. and foreign issuers. Standalone Regulation S offerings involve transactions conducted exclusively in one or more countries outside the U.S. In contrast, combined Regulation S offerings encompass offerings outside the U.S. and Rule 144A offerings within the U.S. territory. Additionally, Regulation S accommodates continuous offering programs for debt securities.

Regulation S also extends its provisions to offerings of foreign government securities, as well as offerings made under specific conditions under an employee benefit plan administered according to the laws of such country. It is important to note that such offerings must still comply with the respective foreign law to ensure compliance on an international scale.

To maintain the integrity of Regulation S, the SEC emphasizes the importance of implementing reasonable procedures to ensure that offers and sales are conducted in compliance with the regulation. This may include employing customary practices for international offerings, verifying the status of the purchaser as a non-U.S. person, and ensuring that resales are restricted in accordance with Regulation S provisions.

Who can rely on Regulation S?

Both reporting and non-reporting U.S. and foreign issuers can rely on Regulation S, availing themselves of the registration exemption provided under Rule 901's general statement and the safe harbor of Rule 903. This exemption extends to distributors, respective affiliates of issuers, and any person acting on behalf of an issuer, distributor, or affiliate, who may be involved in hedging transactions, such as interest rate swap transactions or other derivative securities.

Regulation S is accessible to non-U.S. resident purchasers, including natural person residents, and U.S. residents who are not offering participants. However, it is important to note that certain types of investment companies are not eligible for this exemption. For instance, open-end investment companies and unit investment trusts registered or required to be registered under the Investment Company Act of 1940 cannot rely on Regulation S.

Moreover, closed-ended investment companies that are required to be registered under the 1940 Act but have not done so also cannot utilize Regulation S. In these cases, the specific securities offered by these entities, such as guaranteed securities or convertible securities, do not qualify for the registration exemption provided under Regulation S.

Requirements

Regulation S imposes certain requirements to ensure compliance with its provisions. Primarily, the offer and sale of securities must be conducted in offshore transactions, targeting investors that are natural persons resident outside the U.S. It is crucial that U.S. investors are not shown the terms applicable to non-U.S. investors to avoid violating the regulation.

While there is no mandatory SEC registration for Regulation S offerings, issuers must follow proper methods and implement other reasonable procedures to ensure compliance with the regulation. In this context, it is customary to engage an attorney who specializes in securities law to draft a Private Placement Memorandum (PPM) and Subscription Agreement for the offering. These documents describe the investment in legal and financial terms, providing transparency to potential investors.

With the PPM and Subscription Agreement in place, issuers can raise capital online through platforms that facilitate Regulation S offerings, provided both parties agree to collaborate. It is essential to maintain accurate records and adhere to the same restrictions applicable to such securities during the distribution compliance period, as well as comply with any foreign law that may apply to the offering in the foreign jurisdiction where the securities are offered.

What challenges do companies face using Regulation S?

1. Misunderstanding of Categories. Companies, particularly those in the crowdfunding space, may incorrectly conduct a Regulation S offering by ignoring the fact that there are three separate categories based on the likelihood of the transaction being made in the United States or the securities returning to the U.S.

2. Non-Compliance with SEC Rules. Non-reporting U.S. companies may disregard the stricter rules that apply to them, potentially leading to non-compliance with SEC requirements. This could result in legal consequences and harm to investors if the securities end up in the U.S.

3. Complexity of Foreign Law. Companies using Regulation S may face challenges in navigating the complexities of foreign law. The foreign law prevents them from fully complying with certain aspects of the regulation. This may require legal consultation to ensure compliance with both U.S. and foreign regulations.

4. Determining Beneficial Ownership. Issuers must ensure that they are selling securities to non-U.S. investors and not unintentionally allowing U.S. persons to acquire beneficial ownership of such securities. This may require implementing reasonable procedures to verify the status of investors.

5. Ensuring Offshore Transactions. Companies must ensure that offers and sales are conducted offshore and that no directed selling efforts are made in the U.S. This may involve implementing controls to prevent U.S. investors from accessing offering materials and participating in the offering.

What qualifies as an “Offshore Transaction?”    

An "Offshore Transaction" under Regulation S is a sale of securities that meets certain criteria:

• The offer is not made to a person in the United States.

• The buyer is outside the U.S., or the transaction is executed on the trading floor of a foreign exchange.

• The market participant may establish a "reasonable belief" that the buyer was located outside the U.S.

However, offers and sales targeted at specific groups of U.S. citizens living abroad, such as members of the armed forces serving overseas, are not considered offshore transactions. Conversely, offers of securities to those excluded from being classified as a "U.S. person" because a corporation organized abroad and is deemed made in offshore transactions.

Regulation S vs. Regulation D  

• Investor Qualification. Regulation S allows companies to raise capital from non-U.S. investors, including natural person residents, without any wealth or sophistication requirements. In contrast, Regulation D primarily targets accredited investors, who are individuals or entities meeting specific income, net worth, or asset thresholds. Non-accredited investors may also participate in Regulation D offerings, but their involvement is subject to certain limitations and additional disclosure requirements.

• Offering Location. Regulation S is designed for offshore transactions, where offers and sales of securities, such as convertible securities or underlying securities, are made outside the United States to non-U.S. investors. Regulation D, on the other hand, is intended for domestic offerings within the United States, where securities are offered and sold to U.S. investors.

• Integration With Other Offerings. Regulation S can be used in conjunction with other securities exemptions, such as Regulation D, allowing companies to raise capital from both U.S. and non-U.S. investors simultaneously. This may involve offering convertible securities or other types of securities to accommodate different investor requirements. In contrast, Regulation D offerings must comply with specific integration rules to prevent multiple concurrent offerings from being considered a single offering, which could potentially violate securities laws.

• Resale Restrictions. Securities offered under Regulation S, such as restricted securities or definitive securities, are subject to resale restrictions during a distribution compliance period, typically lasting 40 days for a reporting issuer and one year for non-reporting issuers. These restrictions may apply to the person exercising the resale, and the securities delivered must comply with such regulations. Regulation D securities are also considered "restricted securities," subject to resale limitations, but they may be held indefinitely by the initial purchaser without affecting their exemption status.

• Disclosure Requirements. Regulation S does not impose specific disclosure requirements, but issuers are still subject to anti-fraud provisions and may need to comply with disclosure requirements in the foreign jurisdictions where the securities are offered. Regulation D, however, has specific disclosure requirements for certain offerings, such as providing a private placement memorandum (PPM) to potential investors. This document outlines the terms and conditions of the offering, including any hedging transactions involving the securities or other relevant information. In some cases, a comparable document may be provided to non-U.S. investors in Regulation S offerings, depending on the applicable foreign law.