Reg S; Rule 901: the “general statement”
Rule 901, the 'General Statement' relating to Reg S explains that;
"If one can demonstrate that no directed selling efforts are made within the U.S. and the sale of securities occurred outside the U.S. then registration requirements will not apply."
Clem Turner: When you look at the definition of 'directed sales efforts' in Regulation S, as well as in the preliminary notes, one of the exceptions is the communication with people who are excluded from the definition of a U.S. person. A U.S. person is defined as anyone who is a resident of the United States. This creates a lot of controversy, an issue, when our clients want to pitch to people that are in the United States, but here on temporary visas, such as a student visa, for example.
Some immigration lawyers take the position that a student visa is a non-resident visa, and temporary by nature. Accordingly, that person should not be deemed a resident of the United States, and could technically be excluded from the definition of a U.S. person.
There are some “no action” letters that speak to the issue of the applicability of Reg S as it applies to an offshore transaction. It's a gray area as to whether or not directed selling efforts have taken place. One could argue if they're only speaking to immigrants here in the U.S. on a so-called “transient” visa, sales efforts which commence in the United States to that specific subclass may not satisfy the definition of 'directed selling efforts' being made within the United States.
It's a risky argument, and one that you may not want to make if you have a plaintiff's attorney arguing that the people that you’re selling to are considering an EB-5 visa, which is permanent. Thus, the question is 'have they become U.S. persons?' Maybe they have and maybe they haven't. I haven't seen any guidance from the SEC on that particular question so you take that action at your own risk.
Kurt Reuss: I think it’s good that we’re opening a dialogue on this matter. Obviously it’s something we're all aware is happening, but whether it should be happening I’m not sure. Bob, what's your sense of it?
Robert Cornish: Looking back at the definition of a U.S. person as found in rule 901(k) of Reg S, there’s a specific list of people deemed 'a U.S. person'. There is also a specific list of entities and others who are not deemed U.S. persons for purposes of Regulation S. In my opinion you have to treat Reg S as a territorial safe harbor. That means you have to first look at where the conduct is taking place, then to whom the conduct is directed. That being said, and given the SEC’s penchant for reading the rules exactly as they're written, Rule 901(k) has five or six categories of people or entities that are U.S. persons for Reg S, and another list of five or six that aren't. I think you would likely encounter the argument that if there was to be a certain exclusion or inclusion of people within Regulation S, it would already be included in the definition of 901(k), but it isn't.
We advise anyone relying on Reg S to not engage in U.S. activity, and simultaneously, as permitted under Reg S, to claim a Reg D exemption as a fallback position. Of course, that means you're going to be subject to advertising restrictions. You're going to be subject to making sure everyone is accredited. Going through the whole routine of a Reg D placement, that at least gives you a small fallback position. In terms of the 'no action' guidance though, it’s not very clear.
There are SEC guidance letters that specifically say, for example, if I have a French national on U.S. soil, and I'm directing an investment to that person, I'm probably not availing myself properly of Reg S, and I'm blowing the exemption. Again, this goes to the directed selling effort.
Kurt Reuss I’m still confused as to certain aspects of the origins of Reg S history. It seems the SEC's intent under EB-5 was to allow issuers to compete in international markets. They didn't want to require the world to be registered under U.S. securities laws. But at the same time the SEC seemed concerned that these issues might come back to the U.S..
Now with EB-5, that’s highly unlikely, right? In most cases you're talking to foreigners who are primarily interested in getting a green card and the investment is ancillary to that. It would be very unlikely that those people would be turning around and selling those offerings into the U.S. Yet, here we are talking about the definition of 901(k). How much does the reality of the situation come into play when the SEC looks at these definitions and takes action against people?
Robert Cornish: I think it's clear that Reg S was not intended or designed with EB-5 investment in mind. They are unique in the way that you have people who are not U.S. citizens making a U.S. investment for something other than investment purposes, or with enhanced investment purposes. The idea of the 504 in Reg D is that we have investments in the United States. The flow back is almost legislatively mandated by the fact that the money is supposed to stay in the United States to create jobs.
Kurt Reuss: Isn't flow back primarily related to the idea that the SEC wants to protect U.S. citizens from investing in offerings that haven’t been properly vetted or undergone due diligence? That really wouldn't be happening, even though the money's coming back.
Robert Cornish: These investors are ultimately going to be defined as a U.S. person. Why are we treating them differently? We're letting somebody avail themselves of the securities laws section for the purpose of bringing money into the United States, and having people become residents of the United States. I don't think there's any discussion in any of the EB-5 legislation floating around that even refers to Reg S, other than the fact that if you're doing one of these things, you have to comply with Federal securities law.
Kurt Reuss: Jackie, do you have any thoughts about this?
Jackie Prester: I have no knowledge that Reg S was adopted with EB-5 visa requirements in mind, but that doesn't mean that EB-5 offerings can't take advantage of the Reg S exemption, as long as it's structured right. There are a couple of key considerations. Under Reg S, the people who are buying the securities cannot be U.S. persons. That obviously fits in neatly with EB-5 because the people aren't U.S. persons. The real crux is 'directed selling efforts'. The concept is you can advertise to your heart’s content overseas, but none of that advertising or general solicitation should make its way back to the U.S. for the purpose of generating U.S. interest.
In EB-5 the problem comes when you have issuers marketing to foreigners who happen to be here in the United States. Either they're students, or they're here temporarily, and they still want to pursue the EB-5 program. Then the question is can you really market here in the United States to people who are not U.S. persons? I think that's where you're in a dangerous zone. There is language in Reg S that says it's not directed selling efforts if a foreigner comes to the U.S., say to inspect a plant inspection or for some sort of due diligence trip.
It is pretty clearly that if the non-U.S. person signed a subscription agreement here in the U.S., that you cannot avail yourself of the Reg S exemption. The key takeaway here is that all the activities, to the extent possible, ought to be offshore. If a prospective investor is here, say, temporarily as a student, it makes a lot of sense to focus on fitting within the Reg D exemption instead of trying to hang your hat on Reg S.
Clem Turner: I would like to concur. Generally, whenever someone is here in the United States we try to fit them into the Reg D exemption. However, in the case of students it can sometimes be difficult if they aren't accredited investors; the results, then, can be somewhat “kooky.”
The territorial limitations in Reg S are somewhat relaxed in terms of what directed selling efforts are, because you can come for a site visit. The SEC will allow “isolated, limited contact” within the United States, whatever that means.
On the other hand, the SEC has an exemption that says that communications with people who are not, by definition, a U.S. person doesn’t count as a directed selling effort. The argument can be made that you can find support in the tax code or under immigration law that these students are non-U.S. people, but that only satisfies one prong of the task. The second prong is that it has to take place in an offshore transaction. It is fairly clear from the 'no action' letters that a subscription agreement signed in the United States is going to blow that second prong.
The sale of the securities, via sale or buy order, has to occur outside of the U.S.. You can pitch to foreign students, but when it comes time to sell, they actually have to go to Canada or Mexico, or their home country to sign the documents. As I said, it seems to be a somewhat kooky result. It's not a set of facts I would like to defend, although, as a technical matter it might comply with Reg S. The issuer must consider such factors in the EB-5 business plan while making the offering.