What is 'Regulation S' and How Did It Come Into Being?



'Regulation S' is simply a series of rules that clarify the SEC's position, that securities offered and sold outside of the U.S. do not need to be registered with the SEC. Clem, could you give us a little background on Reg S and how it came about?

Clem Turner: Reg S is essentially a codification of the fact that the SEC understands its role is to govern security offerings within the United States, and to protect investors who invest inside the United States. It is intended to clarify that to the extent an offering is made primarily for offshore investment that it would be a valid exemption under the registration requirement of Section 5. 

Kurt Reuss: From what I've read about the development of Reg S, the SEC’s intention essentially was to say; "You can sell securities outside the U.S., we just don't want unregistered issues to be relied upon by U.S. persons." Is that essentially how you see it?

Clem T: Yes, that is. There are also a variety of legends that are required to be put on subscription agreements that are sold in connection with Reg S. Securities certificates that are issued in Reg S mandates that if the security ends up back in the United States, it must do so pursuant either to a registration or another exemption from Section 5. Section 5 requires that all securities be registered unless they meet an exemption. Reg S is one of those exemptions, and if these securities do come back into the United States, then the issuer needs to find another exemption. 

Kurt R: It seems the SEC is very concerned about 'flow back'. What does 'flow back' mean, and do you think that that essentially was the SEC’s major concern?

Clem T: I do think it was, among others. Primarily, the SEC is concerned with U.S. issuers trying to take advantage of Reg S by selling their securities into another country, and then, through resales, having those securities come back to the U.S., paper compliance with "an offshore transaction" and is nothing but a sham transaction designed to get their securities into the United States without an otherwise valid exemption. Flow back was probably the biggest concern that the SEC had when it pondered this. 

There's a lot of talk in the preliminary notes to Reg S, as well as discussions about limitations on resale that try to address this issue. They divided transactions into three distinct categories that were ranked based on the likelihood that the security could flow back into the United States. Those categories where flow back was deemed more likely had more restrictions with respect to legends. It also had more restrictions with respect to time periods and other things to attempt to prevent the flow back issue. Let me add that in the preliminary notes to Reg S, the SEC also makes it abundantly clear that Reg S only serves as an exemption under Section 5. 

It doesn't shield you from any fraud liability. It also doesn't shield you from the need to comply with any other securities regulations such as 1940 Investment Company Act or the 1934 Exchange Act with respect to information being given to investors. It is solely to be used as an exemption from securities registration, and under no circumstances are any other laws connected with an issuer's offering relaxed because they relied on Reg S. 

Kurt R: Jackie, can you tell the audience what registration entails and thus what is the benefit that 'Reg S' offers issuers by not having to register their offering?

Jackie Prester: To register shares with the SEC requires filing a Form S-1 for someone who's not already a public company. Generally, a registration statement can contain several hundred pages of information, all of which must be absolutely accurate. There's quite a lot of work that goes into the filing of the registration statement. 

More importantly, the SEC scrutinizes every single page of it. In doing so, you've got a review and comment process that goes back and forth time and again. It can easily take up to a year to get securities registered. Moreover, the process can get extremely expensive; $1 million isn’t unheard of, given accounting expenses, legal fees, etc. Once the security is registered, you're subject to the Exchange Act’s financial reporting requirements, i.e. 10-Qs, 10-Ks, so there are also ongoing expenses in terms of maintaining your registration. 

Kurt R: Let’s assume an offering “blew” its Reg S exemption. They would then be required to register, follow the registration requirements, and be held accountable to that level. Is that right, Jackie?

Jackie P: Under Federal securities laws if someone offers and sells securities that should have been registered but were not, there are a number of different remedies. The SEC can impose injunctive relief, meaning you have to stop your offering until you get it properly registered. They can also impose penalties and fines. Investors, under the Federal securities laws, have the right to rescind and request their money back plus interest. States may also have applicable penalties, fines, sanctions and remedies. 

This post originally appeared on EB-5 Diligence. Reprinted with permission.

About The Author

Jackie Prester from Baker Donelson.

Clem Turner from Homeier & Law

Kurt Reuss from Primary Capital

The opinions expressed in this article do not necessarily reflect the opinion of ILW.COM.