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This article features securities attorneys Clem Turner and Jackie Prester, and registered securities broker Kurt Reuss, who works exclusively with EB-5 investments.
"Reg S," which refers to Regulation S, is a series of rules that clarify the position of the U.S. Securities and Exchange Commission (SEC) that securities offered and sold outside the U.S. don't need to be registered with the SEC.
Kurt Reuss: Clem, could you give us a little background on Reg S and how it came about?
Clem Turner: Reg S is essentially a codification of the fact that the SEC understands its role is to govern security offerings within the United States, and to protect investors who invest inside the United States. It is intended to clarify that to the extent an offering is made primarily for offshore investors that it would be a valid exemption under the registration requirement.
Kurt Reuss: The SEC’s intention essentially was to say, "If you restrict your offering to selling your security outside the U.S., then we don’t need to be involved; we just don't want unregistered investment offerings to be relied upon by U.S. persons, even indirectly." Is that essentially how you see it?
Clem Turner: Yes, it is. There are also a variety of legends, disclosures of restrictions, that are required to be put on subscription agreements that are sold in connection with Reg S.
Clem Turner: Securities certificates that are issued under Reg S are mandated that if the security ends up back in the United States, it must do so pursuant either to a registration of the security or another exemption from Section 5.
Section 5 requires that all securities be registered unless they meet an exemption. Reg S is one of those exemptions, and if these securities do come back into the United States, then the issuer needs to find another exemption.
Kurt Reuss: It seems the SEC is very concerned about "flowback." What does flowback mean, and do you think that that essentially was the SEC’s major concern?
Clem Turner: I do think it was, among others. Primarily the SEC is concerned with U.S. issuers trying to take advantage of Reg S by selling their securities into another country, and then, through resales, having those securities come back to the U.S., essentially papering compliance with "an offshore transaction."
They wanted to avoid a sham transaction designed to get their securities into the United States without an otherwise valid registration exemption. Flowback was probably the biggest concern that the SEC had when it pondered this.
There's a lot of talk in the preliminary notes to Reg S, as well as discussions about limitations on resale that try to address this issue. They divided transactions into three distinct categories that were ranked based on the likelihood that the security could flowback into the United States.
Those categories where flowback was deemed more likely had more restrictions with respect to legends. It also had more restrictions with respect to time periods and other things to attempt to prevent the flowback issue. Let me add that in the preliminary notes to Reg S, the SEC also makes it abundantly clear that Reg S only serves as an exemption under Section 5.
It doesn't shield you from any fraud liability. It also doesn't shield you from the need to comply with any other securities regulations such as 1940 Investment Company Act or the 1934 Exchange Act with respect to information being given to investors.
It is solely to be used as an exemption from securities registration, and under no circumstances are any other laws connected with an issuer's offering relaxed because they relied on Reg S.
Kurt Reuss: Jackie, can you tell the audience what registration entails and thus what is the benefit Reg S offers issuers by not having to register their offering?
Jackie Prester: To register shares, the SEC requires filing a Form S-1 for someone who's not already a public company. Generally, a registration statement can contain several hundred pages of information, all of which must be absolutely accurate. There's quite a lot of work that goes into the filing of the registration statement.
More importantly, the SEC scrutinizes every single page of it. In doing so, you've got a review and comment process that goes back and forth time and again. It can easily take up to a year to get securities registered.
Moreover, the process can get extremely expensive; $1 million isn’t unheard of, given accounting expenses, legal fees, etc. Once the security is registered, you're subject to the Exchange Act’s financial reporting requirements, i.e. 10-Qs, 10-Ks, so there are also ongoing expenses in terms of maintaining your registration.
Kurt Reuss: Let’s assume an offering blew its Reg S exemption. They would then be required to register under Reg D and be held accountable to that level. Is that right, Jackie?
Jackie Prester: Under Federal securities laws if someone offers and sells securities that should have been registered but were not, there are a number of different remedies. The SEC can impose injunctive relief, meaning you have to stop your offering until you get it properly registered. They can also impose penalties and fines. Investors, including EB-5 investors, under the Federal securities laws, have the right to rescind and request their money back plus interest. States may also have applicable penalties, fines, sanctions and remedies.
This article was adapted from a webinar featuring securities attorneys Clem Turner and Jackie Prester, hosted by Kurt Reuss, a registered securities broker working exclusively in EB-5.