SEC Issues New C&DIs on Rule 144A and Regulation S

Practical Law Legal Update w-004-9572 (Approx. 6 pages)

SEC Issues New C&DIs on Rule 144A and Regulation S

by Practical Law Corporate & Securities

Rule 144A

Four of the new C&DIs address the issue of whether certain types of securities may be counted in calculating whether an entity meets the $100 million threshold used in determining QIB status under Rule 144A(a)(1)(i). In the situations addressed in two of the new C&DIs, the Division concludes that specified securities may be included in determining whether the $100 million threshold is met:

In new Question 138.05 of the Securities Act Rules C&DIs, the Division states that securities that an entity purchased and continued to hold on margin may be included in calculating whether the entity meets the threshold. The Division notes that the fact that securities were purchased or are held on margin does not mean they are not owned by the entity. They may be counted in the calculation so long as they are not subject to a repurchase agreement (such securities being excluded from the calculation by Rule 144A(a)(2)).
In new Question 138.06 of the Securities Act Rules C&DIs, the Division concludes that securities that an entity owns but has loaned out to borrowers of securities may be included in the $100 million threshold calculation. Again, the Division notes that the fact that the entity has loaned the securities does not mean that the entity does not own them.

In the situations addressed in the other two C&DIs, the Division concludes that certain other securities may not be included in making the $100 million threshold calculation:

In new Question 138.07 of the Securities Act Rules C&DIs, the Division states that securities that an entity has borrowed may not be included in the threshold calculation. This is because securities an entity has borrowed are not owned by it.
Similarly, in new Question 138.08 of the Securities Act Rules C&DIs, the Division concludes that an entity may not include in the calculation short positions in securities that it has established. This is because short positions do not represent ownership of securities but rather sales of securities.

New Question 138.09 of the Securities Act Rules C&DIs addresses a similar $100 million threshold issue related to Rule 144A(a)(1)(iv). That section of Rule 144A provides that the QIB definition includes an investment company that is registered under the Investment Company Act of 1940 (ICA) and is part of a family of investment companies which own in the aggregate at least $100 million in securities of unaffiliated issuers. The Division concludes that where an investment company which is not registered under the ICA is "part of a family of funds, some of which may or may not be registered investment companies," the "non-registered investment company" may not "aggregate investments by the other funds that are part of the family in the manner described under Rule 144A(a)(1)(iv)."

In new Question 138.10 of the Securities Act Rules C&DIs, the Division concludes that only the limited partners (and not the general partner) of a limited partnership may be considered equity owners in determining whether all of the equity owners are QIBs for purposes of Rule 144A(a)(1)(v). The Division states that the general partner of a limited partnership "need not be considered" in determining the QIB status of the limited partnership's equity owners, unless the general partner is also a limited partner. Therefore, the only question in determining the QIB status of a limited partnership under Rule 144A(a)(1)(v) is whether all of the limited partners are QIBs.

To learn more about Rule 144A offerings, see

Regulation S

The new C&DIs relating to Regulation S are summarized below.

Definition of US Person

In new Question 276.01 of the Securities Act Rules C&DIs, the Division considers the issue of what factors should be applied to determine whether an individual satisfies one of the criteria for inclusion in the definition of "US person" in Rule 902. This definition is central to determining the availability of several of the Regulation S safe harbors because these safe harbors apply to a transaction only if no US person is involved in it. Rule 902(k)(1)(i) provides that this term includes a natural person resident in the United States. In the new C&DI, the Division states that each of the following persons will be considered a natural person resident in the United States and, therefore, a US person:

A Green Card holder (i.e., a person who has permanent resident status in the US).
Any other individual without permanent resident status who is deemed to be a resident of the United States according to criteria determined by the issuer. The Division states that an issuer must decide what criteria it will use to determine residency and apply that criteria consistently and without making any changes to achieve a desired result. Possible criteria the issuer may apply are:
- tax residency;
- nationality;
- mailing address;
- physical presence;
- the location of a significant portion of the individual's financial and legal relationships; or
- immigration status.

Conditions for the Availability of Certain Safe Harbors in Rule 903

The other five new C&DIs interpret various provisions of Rule 903, which contains the safe harbors from Securities Act registration for offshore transactions by or on behalf of issuers, distributors, and their affiliates:

In new Question 277.02 of the Securities Act Rules C&DIs, the Division interprets Rule 903(b)(1)(ii), which provides a safe harbor from Securities Act registration for an offer or sale of securities, if, among other things, it is directed into a single country other than the US to the residents of that country and it is made in accordance with the local laws and customary practices and documentation of that country. The C&DI asks whether an issuer may rely on Rule 903(b)(1)(ii) for an offering of securities in two or more countries that are part of the European Union (EU). The Division concludes that the issuer may rely on Rule 903(b)(1)(ii), despite the fact that the offering involves more than one country, if EU laws and practices are the prevailing rules. The Division goes on to state that:
- Regulation S was adopted before the integration of EU capital markets resulting from EU-wide laws and regulations governing those markets; and
- 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 EU rather than of a single country within the EU.
In new Question 277.03 of the Securities Act Rules C&DIs, the Division interprets Rule 903(b)(1)(iv), which provides a safe harbor for an offer or sale of securities to the employees of the issuer or its affiliates under an employee benefit plan governed by the laws and customary practices and documentation of a country other than the United States. The C&DI asks whether an issuer may rely on Rule 903(b)(1)(iv) if the governing laws are those of the EU rather than those of a country other than the United States. The Division states that the issuer may rely on Rule 903(b)(1)(iv), for the reasons stated in the answer to the previous question (Question 277.02).
New Question 277.04 of the Securities Act Rules C&DIs addresses the application of statements that were made by the SEC in adopting Regulation S with respect to persons relying on a predecessor provision to the "Category 2" safe harbor in Rule 903(b)(2). In these earlier statements, the SEC said that:
- any person relying on the Category 2 predecessor 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; and
- the safe harbor would not apply if an offer and sale were made "nominally to non-US persons to evade the restriction."
The current Category 3 safe harbor in Rule 903(b)(3) contains specific certifications, agreements, requirements for legends and global security certificates, and other restrictions on offers or sales to, or for the account or benefit of, a US person. In the new C&DI, the Division states that a person relying on the Category 3 safe harbor may apply the SEC's earlier guidance in establishing that offers and sales are not made to or for the account or benefit of a US person.
In new Question 277.05 of the Securities Act Rules C&DIs, the Division states that the certifications and agreements required under Regulation S (such as those required under Category 3 and those required with respect to warrants) may be provided electronically, with the same effect as if furnished on paper.
New Question 277.06 of the Securities Act Rules C&DIs addresses the application of Rule 903(b)(4) relating to guaranteed debt securities, which states that where debt securities of an issuer are fully and unconditionally guaranteed by its parent, only the requirements of Rule 903(b) that apply to the guarantee must be satisfied with respect to the offer and sale of the guaranteed debt securities. The Division states that Rule 903(b)(4) would apply when the parent company is the issuer (or a co-issuer) of the debt securities and one or more subsidiaries is a guarantor, and when the parent company is a guarantor and there are one or more subsidiaries which are also guarantors, as long as the parent company's payment obligation is full and unconditional.

To learn more about Regulation S offerings (which are often conducted in conjunction with Rule 144A offerings), see:

SEC Issues New C&DIs on Rule 144A and Regulation S | Practical Law