What Is Regulation S? Key Conditions and Resale Limitations

Understanding Regulation S

Regulation S, adopted by the U.S. Securities and Exchange Commission (SEC) in 1990, provides clarity for offers and sales of securities occurring outside the United States. It functions as a safe harbor from the registration requirements of Section 5 of the Securities Act of 1933. This framework supports international capital markets by allowing companies to raise funds globally without undergoing the often lengthy and costly U.S. registration process, provided certain conditions are met.

Regulation S exempts genuinely offshore transactions from U.S. registration requirements, recognizing the U.S. regulatory interest primarily lies in offerings within its borders. This exemption focuses on the location of the transaction, not the nationality of the issuer or investor. This regulatory approach helps facilitate cross-border capital raising, making it quicker, more discreet, and less expensive for issuers compared to full U.S. registration. The SEC designed Regulation S to protect U.S. capital markets and investors by preventing the unregistered flowback of securities into the United States.

Regulation S is not a “filing” itself, but rather an exemption from registration that issuers and sellers must comply with. It encompasses various financial instruments, including debt securities, equity securities, and convertible notes. The regulation applies when a U.S. company issues securities solely to foreign investors or when a U.S. investor purchases foreign securities in an offshore market.

Key Conditions for Exemption

To qualify for the Regulation S exemption, an offering must satisfy two general conditions. The first condition requires that the offer and sale of securities must be made in an “offshore transaction.” This means the offer cannot be made to a person in the United States. In an offshore transaction, either the buyer must be physically located outside the United States at the time of the buy order, or the seller must reasonably believe the buyer is outside the United States. Alternatively, the transaction can be executed on an established foreign securities exchange. These criteria ensure that the principal activity of the offering occurs outside U.S. jurisdiction.

The second general condition prohibits “directed selling efforts” in the United States. This term refers to any activity undertaken to condition the market in the U.S. for the securities being offered under Regulation S. Such activities include placing advertisements in publications with a general circulation in the U.S. that refer to the offering. Activities like roadshows conducted in the U.S. or advertisements in U.S. newspapers would constitute prohibited directed selling efforts.

Limited activities, such as tombstone advertisements in certain U.S. publications, may be permissible if they meet specific conditions, including stating the securities are not registered and cannot be offered or sold in the U.S. Issuers and distributors must ensure no activities are undertaken that could be perceived as an effort to market the securities to U.S. persons during the offering period and any applicable distribution compliance period. The aim is to prevent the circumvention of U.S. registration requirements by indirectly targeting the U.S. market. While these two general conditions apply to all offerings relying on Regulation S, additional conditions and restrictions can vary depending on the type of issuer and the nature of the security being offered. The SEC categorizes offerings into different levels of risk for flowback, with higher-risk offerings subject to more stringent conditions to ensure compliance.

Resale Limitations

Securities offered under Regulation S, though initially offshore, are often considered “restricted” under U.S. securities laws, limiting their free trade in U.S. public markets without further conditions or exemptions. A key concept governing these resales is the “distribution compliance period.” This is a timeframe during which certain restrictions apply to prevent the securities from flowing back into the United States.

For debt securities, this period typically lasts 40 days. For equity securities, the distribution compliance period is generally longer, lasting six months for securities of reporting issuers and one year for equity securities of non-reporting issuers. This period begins on the later of the date the securities were first offered to persons other than distributors or the closing date of the offering. During this time, securities generally cannot be offered or sold to U.S. persons unless through another valid exemption or registration.

Even after the distribution compliance period expires, sellers cannot automatically resell these securities into the United States without further compliance. They must adhere to U.S. securities laws, specifically Section 5 of the Securities Act, unless another exemption, such as Rule 144 or Rule 144A, applies. Equity securities of domestic issuers acquired under Regulation S are generally deemed “restricted securities” under Rule 144 and retain this status even after a Regulation S resale.

Purchasers of Regulation S securities, especially during the distribution compliance period, are typically required to certify they are not U.S. persons and agree not to resell the securities except in compliance with Regulation S or another exemption. The securities themselves often carry restrictive legends, which are notices indicating their restricted status and the applicable resale limitations. These legends serve as a clear warning to potential purchasers about the trading restrictions.

Implications for Investors

Investing in securities offered under Regulation S carries distinct considerations for the average investor. A primary concern is the potential for limited liquidity. While the initial offering is conducted offshore, the securities face restrictions on resale into the U.S. market, particularly during the distribution compliance period. Even after this period, reselling into the U.S. typically requires meeting the conditions of another exemption, such as Rule 144, which can involve holding periods and other requirements. This structure means investors might find it more challenging or time-consuming to sell their shares compared to securities registered for public trading in the U.S.

Another implication for investors is that Regulation S offerings are generally not subject to the same level of disclosure and regulatory scrutiny as securities registered with the SEC for public sale in the U.S. This can result in less publicly available information about the issuer and the securities themselves. Investors should understand that these offerings bypass the rigorous disclosure requirements mandated for typical U.S. public offerings.

Therefore, conducting thorough due diligence is particularly important for investors considering Regulation S securities. Given the potentially reduced public information and resale limitations, investors should carefully evaluate the issuer’s financial health, business operations, and the specific terms of the offering. Understanding these aspects helps investors make informed decisions when encountering such investment opportunities.