JonathanNzali Tips
The depth and breadth of the equity and debt capital markets in the United States has been a key driver of the country’s economic success. By making capital available to companies of all sizes, from start-ups in Silicon Valley to blue chips on Wall Street, the U.S. system has helped fuel innovation and often given US companies an edge internationally. Through the creation of Rule 506(c) (defined thru the three parts in this serie) and other changes to the rules governing capital raisings in the United States, lawmakers in the United States have sought to open the capital markets even further.
Despite the buoyant markets in the United States, non-U.S. companies are often reluctant to raise funds there due to the relatively litigious nature of U.S. investors(yes, these folks like to sue the life out of you for any flimsy perceived unsatisfactory act they feel entitled to crusade for a change and the system allows it such frivolous nonsense) the perceived complications related to the U.S. rules and regulations and the simple fact that reaching investors in the United States can be difficult, particularly for companies that aren’t located or very active in the United States.
The new rules around marketing deals implemented following the Jumpstart Our Business Startups Act (the JOBS Act) and the rise of the utility of the internet, both in marketing and lowering deal costs, could encourage more non-U.S. companies to consider raising funds in the United States.
It’s important to note that while crowdfunding (i.e. Title III of the JOBS Act allowing the raising of relatively small amounts of money from a very large number of non-sophisticated investors) gets most of the press, the creation of Rule 506(c) of the U.S. Securities Act of 1933, as amended (the Securities Act) will probably have a much bigger impact for companies raising money from U.S. investors, in part because: (i) Rule 506(c) (and Rule 506(b), for that matter) has no limit on the amount of funds that can be raised, (ii) the risk profile when dealing with the sophisticated investors involved in Rule 506 deals is much lower than will be the case once non-sophisticated investors are able to participate in crowdfunded deals, (iii) the ongoing reporting and regulatory requirements will be lower for Rule 506 deals, both for U.S. and non-U.S. companies (iv) dealing with a limited number of investors is easier for companies of all sizes, and (v) the changes to Rule 506 (i.e. the removal of the general solicitation/advertising ban and the creation of Rule 506(c)) have created to potential to widely advertise and settle deals on the internet.
What will follow in this serie in three parts include a few of the key considerations in this process and attempted to cut through some of the jargon that often serves as a barrier to raising funds in the United States, both for domestic and non-U.S. companies.
But before any of that, please consult legal counsel before entering this market in any way. The information below is not legal advice (just like any information on Jonathan Nzali Tips, it is only provided as an introduction or a basic acquaintance to complicated subjects. A little knowledge is a dangerous thing and if you make a mistake, even if it is inadvertent, there may be serious legal consequences. Go talk to a lawyer.
Foreign Private Issuers and Regulation S
Companies that access the U.S. public or private capital markets (e.g. offer or sell shares to U.S. investors) become subject to federal and state securities laws in the United States. These laws generally apply to U.S. and non-U.S. companies alike. However, sometimes these laws make accommodations for non-U.S. companies. Often these accommodations, which include relaxed reporting and regulatory requirements, make it easier for non-U.S. companies to access the U.S. markets as these exemptions were implemented with the goal of encouraging non-U.S. companies to enter the U.S. capital markets in certain circumstances. Most of the accommodations for non-U.S. companies are available to non-U.S. companies that meet the definition of “foreign private issuer” (FPI).
Definition of FPI
The term “foreign private issuer” means a national of any foreign country or a corporation or other organization incorporated or organized under the laws of any foreign country except an issuer meeting the following conditions:
- More than 50% of the issuer’s outstanding voting securities are directly or indirectly held of record by U.S. residents; and
- Any one of the following:
- the majority of the executive officers or directors are U.S. citizens or residents;
- more than 50% of the issuer’s assets are located in the United States; or
- the issuer’s business is administered principally in the United States.
Therefore, if 50% or less of an issuer’s outstanding voting securities are held by U.S. residents, the issuer would qualify as an FPI. Furthermore, the issue would still be an FPI if more than 50% of its outstanding voting securities are held by U.S. residents and it does not meet any of the three elements set out in #2 above.
Although these tests appear straightforward, there are a number of complicating factors. For example, determining who actually holds the issuer’s securities for purposes of #1 may involve a “look through analysis” whereby issuers must look through the record ownership to determine whether more than 50% of their voting securities are “beneficially” owned by U.S. residents.
In terms of timing, an issuer is an FPI if it meets the above definition of an FPI on the last business day of its most recently completed second fiscal quarter (though this is different if the issue is registering securities with the SEC for the first time).
It should be noted that although the transaction structures discussed below are available to FPIs and U.S. companies, “non-U.S.” companies seeking to raise funds in the United States should be clear on their FPI status before directly subjecting themselves to U.S. (and SEC) jurisdiction by selling securities to U.S. investors. Again, FPI status is important because if such issuers offer and sell securities to investors in the United States, the issuer will be subject to relaxed reporting requirements and will often be able to rely on compliance with its home-country regulations.
Regulation S
Section 5 of the Securities Act prohibits the offer and sale of a security into the United States absent its registration with the SEC, unless both the offer and sale are made in a transaction that is exempt from, or not subject to, such registration requirements.
Although this expressly relates only to offers and sales into the United States, issuers can unintentionally offer securities into the United States and fall foul of the SEC and the registration requirements set out in the Securities Act. It is therefore useful to quickly touch on what comprises an offer that is not subject to the registration requirements because it is made outside of the United States.
Regulation S provides that offers and sales are not subject to Section 5 if they occur outside of the United States (whether or not the buyers are US or foreign investors). There are two basic conditions applicable to any offering by an issuer made pursuant to Regulation S:
- The offer and sale of the securities must be made in an “offshore transaction”.
- There can be no “directed selling efforts” in or into the United States of the securities offered.
Very generally, the “offshore transaction” requirement means that the offer must be made to a person that is outside of the United States and, when the order to buy shares or securities is originated, the buyer is (or is reasonably believed to be) physically located outside the US.
“Directed selling efforts” is very broad and includes 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 for the securities being offered offshore. This could include nearly any activity that results in information about a fundraising reaching investors in the United States (including over the internet) or even activity that raises the issuers profile in the United States at a time when it is raising funds with non-U.S. investors.
Most non-U.S. companies don’t worry about their FPI status or making sure they fall within Regulation S, particularly if they haven’t had and don’t plan on having contact with U.S. investors. These issuers almost certainly fall within Regulation S, even if they don’t know it. But things can get complicated and it’s an important analysis for companies considering interaction with investors in the United States to stay within Regulation S, if necessary.
There you have it… a few of the key considerations of this process and attempts at cutting through some of the jargon that often serves as a barrier to raising funds in the United States, both for domestic and non-U.S. companies. In the next issue, I will provide you with a analysis on foreign private issuers and regulation S and the different ramifications of applications.
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