Category 2. Category 2 applies to securities that do not meet the qualifications of category 1 and are equity securities of a foreign issuer, or debt securities of a reporting U.S. or foreign issuer or debt securities of a non-reporting foreign issuer. The following additional conditions apply to category 2 securities: (a) offering restrictions must be implemented; (b) the offer or sale, if made prior to the expiration of a 40-day distribution compliance period, is not made to a U.S. person or for the account or benefit of a U.S. person; and (c) each distributor selling securities to another distributor or dealer, or person receiving selling compensation, prior to the expiration of a 40-day distribution compliance period receives a confirmation that they are subject to the same distributor restrictions as the selling distributor.
Category 3 . Category 3 applies to securities that do not meet the qualifications of categories 1 or 2. All category 3 transactions must implement offering restrictions. Additional conditions are imposed depending on whether the securities being sold are debt, equity or warrants/convertible securities. Category 3 covers debt or equity by non-reporting U.S. issuers; equity offerings by U.S. reporting issuers; and equity offerings by non-reporting foreign issuers for which there is a substantial U.S. market interest. Category 3 requires a 40-day distribution compliance period for certain debt securities, six-month distribution compliance period for equity securities of reporting issuers, and a one-year period for equity securities of non-reporting issuers.
Offers and sales of Category 3 securities may be made during the distribution compliance period as long as (i) they are not made to U.S. persons or for the account or benefit of U.S. persons; (ii) the purchaser agrees to resell the securities only in accordance with Regulation S, registration or an exemption from registration and agrees not to engage in hedging transaction with regard to the securities; (iii) the securities contain a legend stating that they may only be sold in accordance with Regulation S, registration or an exemption from registration and cannot be used for hedging transaction; (iv) the Issuer is required, either by contract or a provision in its bylaws or articles, to refuse to register any transfer not made in accordance with these rules; and (v) each distributor selling securities to another distributor or dealer, or person receiving selling compensation, prior to the expiration of a 40-day distribution compliance period receives a notice that they are subject to the same distributor restrictions as the selling distributor.
Additional Conditions for Warrants. Securities underlying warrants are subject to a continuous distribution compliance period as long as the warrants remain outstanding. An offer or sale of warrants under Category 2 or 3 must also comply with the following additional requirements: (i) each warrant must bear a legend stating that the warrant and underlying securities have not been registered under the Securities Act and that the warrant may not be exercised by or on behalf of any U.S. person unless registered or pursuant to an exemption; (ii) each person exercising a warrant must provide a written certification that they are not a U.S. person and that the warrant is not being exercised on behalf of a U.S. person or provide a legal opinion letter that the warrant and underlying securities have been registered or are exempt from registration; and (iii) procedures are implemented to ensure that the warrant may not be exercised with the U.S. and that the underlying securities may not be delivered within the U.S., unless registered or exempt from registration.
Directed Selling Efforts
All Regulation S transactions prohibit directed selling efforts in the U.S. Regulation S defines “directed selling efforts” as any activity undertaken for the purpose of, or that could be reasonably be expected to have the effect of, conditioning the U.S. market for any of the securities being offered in reliance on Regulation S. Directed selling efforts includes placing an advertisement in a publication with a general circulation in the U.S. that refers to the Regulation S offering. In addition, directed selling efforts include traditional solicitation methods such as direct mail, seminars, telephone solicitations, and radio and TV advertisements.
The rule excludes certain activities from the definition of directed selling efforts, including (i) placing an ad required to be published under U.S. or foreign law provided the ad contains no more information than legally required; (ii) contact with non-U.S. persons; (iii) tombstone ads in papers with less than 20% of its circulation in the U.S. and with an appropriate legend; (iv) bona fide visits to real estate, plants and other facilities; (v) distribution in the U.S. of a foreign broker-dealer’s quotations; (vi) a notice in accordance with Rules 135 or 135(c) of the Act, that the Issuer intends to make a registered or unregistered offering; (vii) providing any journalist with access to press conferences held outside of the U.S.; and (viii) publication or distribution of a research report by a broker or dealer.
The prohibition against directed selling efforts is continuous through the offering and the distribution compliance period.
Types of Regulation S Transactions
In addition to traditional stand-alone debt or equity securities offerings, Regulation S can also be used to complete a Rule 144A offering. Rule 144A technically is not an Issuer’s exemption, but rather is a safe harbor for the resale of restricted securities to QIB’s, much as Rule 144 is a safe harbor for the resale of restricted securities generally. However, since its passage in 1990, market participants have used Rule 144A as a means of raising capital for issuers by engaging in a Regulation S offering followed by the immediate resale of such securities to QIB’s in reliance on Rule 144A. This method of raising capital has become widely known as a Rule 144A Offering. Regulation S does not preclude the resale of the same securities offered in the Regulation S offering in a Rule 144A offering, even if the resale occurs during the distribution compliance period, as long as the applicable conditions of the distribution compliance period are met.
Regulation S is also relied upon for continuous debt offerings such as offshore medium-term note programs. In addition, Regulation S can be relied upon for employee benefit plan offerings outside the U.S. and in accordance with the laws of such foreign country.
No Integration – Concurrent Offerings
Regulation S, by its terms, does not integrate with either registered or “domestic offerings that satisfy the requirements for an exemption from registration under the Securities Act.” Accordingly, an Issuer can concurrently conduct a Regulation S offering and a U.S. exempt or registered offering.
A condition to Regulation S is that there can be no directed selling efforts in the United States. Many practitioners have been concerned that the new general solicitation rules would de facto eliminate the ability to engage in concurrent Rule 144A or 506 and Regulation S offerings. Since general solicitation under the new Rule 506(c) or Rule 144A would satisfy the requirements of a US exemption, the SEC will not view concurrent offerings under Rule 506(c) and/or Rule 144A and Regulation S as integrating such as to destroy the Regulation S exemption.
Resale Restrictions
Securities cannot be offered or sold to U.S. person during the distribution compliance period unless the transaction is registered under the Securities Act or exempt from registration. To refresh, there is no distribution compliance period for category 1 securities. The distribution compliance period for category 2 securities is 40 days. The distribution compliance period for category 3 transactions involving debt is 40 days; for the equity of reporting issuers it is six months, and for the equity of non-reporting Issuers it is one year.
Offshore resales may be made as long as (i) offers and sales are made in an offshore transaction (i.e., outside of the U.S.); (ii) no directed selling efforts are made in the U.S. by the Issuer, a distributor, either of their affiliates, or anyone acting on either of their behalf; and (iii) certain enumerated conditions are met, if applicable. In particular, if a resale is made by a distributor or dealer (i) neither the seller nor any person acting on its behalf knows that the buyer is a U.S. person; and (ii) if the sale is to another distributor or dealer, the seller sends a confirmation including a statement that the securities can only be sold during the distribution compliance period in accordance with Regulation S. If an offshore resale is made by an affiliate of the issuer, including an officer or director, no selling concession, fee or other remuneration may be paid other than customary broker’s commissions.
The Author
Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys
LAnthony@LegalAndCompliance.com
Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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