Category Archives: Foreign Broker Dealer

What are the Regulation S Safe Harbor Categories?

There are Three Issuer Safe Harbor Categories under Regulation S

The Regulation S issuer safe harbor contains three categories of offerings, depending on the nationality and reporting status of the Issuer, and whether or not there is substantial US market interest in the securities.

The three categories represent increasing protections to make sure that the securities offered in a Regulation S offering are not part of an unregistered distribution of securities in the United States.

Regulation S Safe Harbor Category 1

The first Issuer Safe Harbor under Regulation S contains the least restrictive conditions and is for offerings of securities of Foreign Companies:

  1. with no substantial US market interest in these foreign securities,
  2. securities offered and sold in “overseas directed offerings,”
  3. securities backed by the full faith and credit of a foreign government, and
  4. securities offered and sold pursuant to certain employee benefit plans.

For offerings in Category 1, there are no requirements other than the Regulation S General Conditions.  Category 1 Regulation S securities are not the subject of legal opinions by US securities attorneys.

Regulation S Safe Harbor Category 2

The second Issuer Safe Harbor under Regulation S applies to offerings that are not eligible for Category 1.  These would include the following:

  1. equity securities of a reporting foreign company; or
  2. debt securities of a reporting foreign or US Issuer or a non-reporting foreign company.

In addition to the Regulation S General Conditions, certain other offering restrictions apply and no offer or sale may be made to a US Person or for the account or benefit of a US Person (other than a distributor) for a period of 40 days.

Category 2 Regulation S securities are rarely the subject of legal opinions by US securities attorneys.  Today it would be very difficult to find a brokerage firm which would accept for deposit any restricted securities using the 40 day holding period.  Most, if not all, of such brokers were based offshore and have since been shut down.  Nevertheless, when some think if Reg S, they assume the holding period is only 40 days.   Even in the heyday of offshore brokerages, this was only true for stock of “reporting” foreign companies, since debt securities would need to be converted into stock anyway in order for deposit and trading.

Regulation S Safe Harbor Category 3

The third Regulation S Issuer Safe Harbor contains the most restrictive conditions and applies to all securities not eligible for Categories 1 and 2. This includes the following:

  1. equity securities of a reporting US Issuer;
  2. any securities of a non-reporting US Issuer; and
  3. equity securities of a non-reporting foreign company that has a substantial US market interest in its equity securities.

Category 3 encompasses nearly all Regulation S securities which are the subject of legal opinions drafted by US securities attorneys.  In practice, the holding period requirements of Reg S Category 3 are similar to Rule 144 for OTCMarkets or OTC Bulletin Board public companies.

Other Offering Restrictions Under Regulation S for Sales to US Persons under Category 3

In addition to the Regulation S General Conditions, certain other offering restrictions apply and no offer or sale may be made to a US Person or for the account or benefit of a US Person (other than a distributor) for the following periods:

Equity securities of Non-Reporting Issuers: One Year.  This is the same as a Non-Reporting OTC Markets Pink Sheet or Voluntary SEC Filer under Rule 144.

Equity securities of Reporting Issuers: Six Months.  This is the same as a Mandatory SEC Filer like an OTCQB or OTCBB stock under Rule 144.

Debt Securities: 40 Days.  In practice, this is of no consequence, because in order for the US Shareholder to deposit and sell stock under Reg S Category 3, “Debt Securities” are converted into “Equity Securities” so the respective Six Months or One Year holding periods will still apply.

Securities Attorneys for Selling Regulation S Stock

As a practical matter, all securities sold pursuant to the registration exemption under Regulation S will undergo scrutiny from brokerage compliance officers when the shareholder attempts to clear stock for resale.

Unless the typical Six Months or One Year holding periods are met, it is highly unlikely that US Shareholders will be able to deposit any Reg S stock, regardless of the public’s impression that the holding period is “only 40 days.”  Once those holding periods are met, it may also be possible to obtain a Rule 144 legal opinion even though the original private offering was done under Regulation S.  If the stock is greater than two years old, it may also be possible for a Section 4(a)(1) opinion to be drafted.

It is important to provide an experienced securities attorney like Matt Stout with all documentation showing the origin and history of the Reg S shares when seeking a legal opinion to clear Regulation S stock.

Regulation S Shareholders can contact securities lawyer Matt Stout at mstout@otclawyers.com or (410) 429-7076 to discuss the Regulation S General Conditions and Safe Harbors at no cost.

What is Regulation S?

Reg S Covers Offers and Sales of Securities to Non US Persons

A brief summary of Regulation S is that it provides safe harbors, and a possible exemption from SEC registration for sales of securities to Non US Persons. For the purposes of Reg S, a US Person would basically be a United States citizen, a US resident, or a corporation, LLC or Trust domiciled in one of the 50 US states.

The most important element of Regulation S is when securities are considered to have “come to rest abroad” so that their resale would not require registration under the Securities Act of 1933 (“Securities Act”).

Reg S Covers Offers and Sales That Occur Outside of the United States

Regulation S uses a “territorial approach” to Securities Act registration, which makes sense because this is a geographical issue.  The basic rules are that offers and sales subject to Section 5 of the Securities Act include any offers and sales occurring within the United States but that they do not include offers and sales that occur outside of the United States.

Must Be an Offshore Transaction with No Directed Selling Efforts in the US

Regulation S also includes several safe harbor exemptions addressing specific types of transactions.  Each Regulation S safe harbor is subject to two general conditions:

  1. The offer or sale must occur in an “offshore transaction.” The Seller must reasonably believe that the Buyer is offshore at the time of the offer or sale.  Or the transaction must happen on certain “designated offshore securities markets.”  This includes Canadian markets.  The transaction cannot be “pre-arranged” with a Buyer in the US.
  2. No “directed selling efforts” may be made within the US by the Issuer, a Distributor, any of their affiliates, or Agents acting on their behalf.  This essentially means no marketing whatsoever within the United States or on the internet, unless the website includes certain disclaimers designed to discourage US Persons from reading the materials.

Reg S Has Many Potential Pitfalls for Issuers and Shareholders

Reg S may sound simple but there are many more caveats associated with its use, including several nuances depending on the type of securities being offered,  and whether the Issuer is a foreign or US based company.  Depending on these factors, Regulation S may treat two OTC Bulletin Board or OTC Markets public companies very differently, and this has an impact on the Shareholder’s ability to cite Reg S as an exemption from registration.

Issuers considering using Regulation S, and Shareholders that own Reg S Shares can contact securities lawyer Matt Stout for further information at (410) 429-7076 or mstout@otclawyers.com

 

 

What is the DTC?

DTC eligibility is a concern of both OTC Issuers and their Shareholders since it determines whether or not an Issuer’s securities can be electronically traded through “book-entry” rather than through the movement of actual paper stock certificates.

If an Issuer’s securities are not DTC eligible, it is difficult to find a market for its shares.  Securities lawyers who practice OTC securities law are often asked questions about DTC eligibility and perhaps the most often is “What is the DTC?”

DTC is the World’s Largest Securities Depository

The Depository Trust Company (“DTC”)  is a wholly-owned subsidiary of The Depository Trust & Clearing Corporation (“DTCC”).  DTC describes itself as “the world’s largest securities depository” and is structured as a limited-purpose trust company and classified as a “banking organization” under the New York Banking Law.

DTC is also a member of the Federal Reserve System, and a  “clearing corporation” under the New York Uniform Commercial Code, and a “clearing agency” registered under the Securities Exchange Act of 1934.

DTC Works With Broker-Dealer Participants Not Directly With Issuers

DTC holds securities of DTC eligible Issuers, provides asset servicing and also facilitates the post-trade settlement among Direct Participants of sales in deposited securities, through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts.

DTC does not work directly with OTC public companies, but rather works through its participating broker-dealers, who sponsor the OTC Issuer’s for DTC eligibility.  These broker-dealers are known as DTC Participants.  Among this list of DTC Participants includes every major broker-dealer, and some smaller or lesser known broker-dealers which specialize in OTC Bulletin Board and OTC Markets securities, both in the US and abroad.

DTC Eliminates the Need to Deliver Physical Certificates

DTC’s book-entry transfers of securities essentially eliminates the need for physical movement of stock certificates for OTC Issuers that are DTC eligible.  Instead, DTC Participants essentially book the transactions electronically between one another and no transfer of physical certificates is necessary.   In addition to brokers and dealers, Direct Participants include both U.S. and non-U.S. securities banks, trust companies, clearing corporations, and certain other organizations.

Indirect Participants Also Have Access to DTC

DTCC is the holding company for DTC, National Securities Clearing Corporation and Fixed Income Clearing Corporation, all of which are registered clearing agencies. DTCC is owned by the users of its regulated subsidiaries.

In addition to access by DTC Direct Participants, access to the DTC system is also available to others such as smaller U.S. and non-U.S. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (“Indirect Participants”).

For this reason, even though Shareholders of OTC Bulletin Board and OTC Markets Pink Sheet stock might have a brokerage account at a little known firm specializing in over-the-counter stocks, these smaller firms clear shares through larger DTC Direct Participants.

The DTC Rules applicable to its Participants are on file with the Securities and Exchange Commission.  More information about DTC can be found at www.dtcc.com.

Foreign Broker Dealer Registration Under the Securities Exchange Act of 1934

Foreign broker-dealers are required to be registered under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”) unless they are exempt under the Foreign Broker-Dealer Exemption (Rule 15a-6).

Every broker dealer which physically operates in the US must register with the SEC even if their business is directed only to foreign investors outside of the boundaries of the United States.

Every foreign broker dealer that attempts to market securities to any person in the United States must also register with the SEC.   This marketing includes the use of the internet, including blogs, websites, and emails to offer securities to US citizens, residents or companies.

Further information on what foreign broker dealers can do to remain exempt under the Foreign Broker-Dealer Exemption is shown in this post by Matheau J. W. Stout, Securities Lawyer.