Implications of the Elimination of the Restriction on General Solicitation for Cross-Border Equity Offerings Under Rule 144A by Foreign Private Issuers
On 11 July 2013, we published a client Alert on the amendments (Amendments), by the U.S. Securities and Exchange Commission (SEC) to Rule 506 and Rule 144A under the Securities Act of 1933, as amended (Securities Act), to permit general solicitation1 of investors in certain private securities transactions.2 The Amendments became effective on 23 September 2013. This Alert focuses on the implications of the Amendments for cross-border offerings of equity securities of non-U.S. companies (foreign private issuers or FPIs) effected in reliance on the exemption from registration provided by Rule 144A.
A large number of equity offerings by FPIs that are already public or that are, concurrently with such offerings, going public in their home market, include a tranche for U.S.-based investors in reliance on the exemption from registration under the Securities Act provided by Rule 144A. Prior to the Amendments, the premise of that exemption was that regulatory oversight provided by SEC registration was not needed when the offer and resale3 of securities, regardless of volume, was made only to a certain type of highly sophisticated institutional investors, called “qualified institutional buyers” (QIBs). Historically, Rule 144A has been widely used in the U.S. for offerings of debt securities but less so for equity security offerings because it is not available for transactions where the securities are fungible with securities listed on a U.S. stock exchange. However, Rule 144A is often used to facilitate the placement to U.S.-based QIBs of equity offerings by FPIs the securities of which are not so listed. A key concern prior to the Amendments was to ensure that a public offering by these FPIs outside the United States did not violate the Rule’s prohibition on general solicitation. The Amendments have eliminated this prohibition without completely eliminating concerns about engaging in widespread publicity in the United States in a transaction of this type.
The Amendment to Rule 144A
The Amendments remove the long-standing requirement that the offer of the securities be limited to QIBs. In other words, provided that actual resales by the initial purchasers or underwriters are made to QIBs, offering the securities to investors other than QIBs does not vitiate the availability of the exemption. Prior to the Amendments, Rule 144A prohibited “general solicitation” in the United States in connection with an offer of securities in order to ensure that the offer itself, and not just the resale, was limited to QIBs. As part of The Jumpstart Our Business Startups Act (JOBS Act), passed in April 2012 by the U.S. Congress, the SEC was required to adopt rule changes removing the ban on general solicitation.4
As a result of the Amendments, Rule 144A may now be relied upon even if a general solicitation is employed to attract investors so long as “[t]he securities are sold only to a qualified institutional buyer or to a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer.” (Emphasis added)
Implications for Deal Management
Transaction-related publicity in the United States that would have formerly constituted “general solicitation” may therefore now be conducted by the participants in an offering relying on Rule 144A, provided that the securities being offered are resold (by the underwriters or the initial purchaser) only to QIBs and that all of the other requirements of the Rule are complied with. What is more, Rule 144A is available even if a resale were to a non-QIB, provided that the entity claiming the Rule 144A exemption had a reasonable belief that the purchaser was a QIB. Rule 144A(d)(1) sets out non-exclusive criteria for asserting a reasonable belief for the prospective purchaser’s status. Investment banks and other market participants have well-established procedures for determining whether investors are QIBs. Most, if not all, of the investors they bring to the table are typically pre-vetted; and the PORTAL Alliance, a closed-market trading platform for restricted securities, is only available to qualified institutions and depositary and clearing systems.
Nonetheless, engaging in unregistered offerings in the United States by means of a general solicitation is not without risk and continues to require careful transaction management. Risks have to be carefully weighed against the potential reward.
For example, the Amendments do not reduce potential civil liability for material misstatements in and/or omissions from any materials or communications that are used to solicit investors. Indeed, Preliminary Note 1 to Rule 144A makes it clear that the safe harbor applies solely to the registration requirements of the Securities Act and not to antifraud or other provisions of U.S. federal securities laws. An investor who decides to participate in the offering may still bring a civil claim for damages or rescission under Rule 10b-5 under the Securities Exchange Act of 1934, as amended (Exchange Act), on the basis that, in making its investment decision, it relied on misleading or incomplete information. Consequently, underwriters, issuers and/or selling shareholders still have a significant interest in ensuring that all information provided to investors in the United States (in this case, QIBs) is accurate and complete and, given the uncertainty over the disclosure requirements U.S. courts would apply in judging the accuracy and completeness of disclosure in this context, most bulge-bracket investment banks will insist that the offering circular or domestic prospectus (usually by way of a wrapper providing supplementary information for U.S. investors) contains information substantially similar to that required in a U.S.-registered offering. Transaction-related publicity beyond the offering circular or the wrapped domestic prospectus raises a concern that such publicity could itself give rise to a Rule 10b-5 claim.
The disclosure concern can be partially addressed, from the underwriters’ point of view, through a combination of contractual arrangements and disclaimers. Contractual arrangements will typically include representations and warranties, as well as an indemnity, from the issuer and/or selling shareholder in connection with any liability that arises from publicity conducted in the United States, as well as a right of approval by the underwriter over any communication regarding the offering. However, U.S. federal case law is divergent on the enforceability of indemnity provisions in the securities context.5 The effectiveness of disclaimers in this unproven context is also subject to some uncertainty.
So much for the risks. The benefits of engaging in transaction-related publicity in the United States in a Rule 144A offering may be marginal, as noted by the SEC in adopting the Amendments:6 The Rule 144A market is by definition comprised of a universe of sophisticated investors, access to whom is relationship-based and mainly through the client lists of the underwriters. The key factor in finding investors in a Rule 144A offering is knowing their preferences and suitability for a particular kind of investment. Investment banks typically do not need to engage in general solicitation to find them. If anything, the client lists of the investment banks is one of their key competitive advantages and they may consequently be indifferent to the new means of finding investors that the Amendments have theoretically created.
Early takers of the relaxed rules on general solicitation are, if anyone, likely to be underwriters below the “bulge bracket” who may welcome the opportunity to cast a wide net to find potential investors from which QIBs may subsequently be vetted for the actual sale. For them, the “large net” benefit of such publicity may outweigh the risks, especially when attenuated through careful management and diligence of the content of transaction-related publicity, including for consistency with the formal offering documents, and confirmation of QIB status of investors actually participating in the sale. In that context, and considering that the underwriters are in the best position to confirm the QIB status of the investors, issuers and/or selling shareholders should seek contractual assurance from the underwriters in the form of representations and warranties relating to the status of the investors.
Many long-standing practices applied to transaction-related publicity in order to avoid a general solicitation in the United States in the context of a cross-border offering that includes a Rule 144A tranche may now be relaxed, provided that the QIB status of purchasers is vetted and subject to appropriate due diligence of the information provided. For example, among others:
press releases may now be broadly distributed in the United States announcing an upcoming offering, the beginning of the subscription period, the actual or potential size of an offering and the names of the underwriters;
there is no need to block U.S. investors from access to websites containing transaction-related or issuer-related information, provided that sales of securities are only made to persons reasonably believed to be QIBs; and
transaction-related press conferences and investor meetings (online, by teleconference or physical) may be held in the United States or abroad (to which U.S. investors may be invited).
Moreover, websites themselves are now a viable method to offer securities, subject of course to the FPI’s domestic securities laws and regulations and U.S. state securities or “blue sky” laws.
In the short term, we expect that the ability to conduct general solicitation activities in the United States in connection with a Rule 144A equity offering is not likely to alter the established market practice to avoid such activities, at least in transactions managed by “bulge bracket” investment banks. Over the medium term, we expect that there is likely to be a gradual relaxation of the significant restrictions traditionally placed by sale-side offering participants to ensure compliance with the general solicitation requirement. The extent of the relaxation in the long term will depend on the investment community’s assessment of the benefits of reaching a somewhat wider QIB universe as compared to the potentially increased exposure to securities fraud claims, based upon allegedly inaccurate or incomplete offering materials and related communications.
1 General solicitations include, but are not limited to, the following: (1) Any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio and (2) any seminar or meeting whose attendees have been invited by any general solicitation or general advertising. In Rule 144A offerings by FPIs, the challenge has frequently been deciding when, in the age of globalized media, publicity activity mainly undertaken outside the United States that may be susceptible to dissemination in the United States would constitute “general solicitation”.
3 The typical Rule 144A offering consists of an issuer initially placing securities with U.S.-based investment banks under the private sale statutory exemption provided by Section 4(a)(2) of the Securities Act. Those investment banks, generally called initial purchasers but effectively acting as underwriters, then resell the securities with US-based “qualified institutional buyers”, or QIBs, as such term is defined under, and pursuant to the requirements of, Rule 144A.
4 “ ... securities sold under such revised exemption may be offered to persons other than qualified institutional buyers, including by means of general solicitation or general advertising, provided that securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer.” Section 201(a)(2) of the JOBS Act.
5 “The enforceability of indemnity agreements in securities suits may not be a settled question, but the judicial zeitgeist seems to steer away from this kind of corporate restitution.”In re Colonial BancGroup, Inc., 2010 U.S. Dist. LEXIS 1169, 13-14 (M.D. Ala. Jan. 7, 2010)
6 The SEC recognized the limited impact of the changes to Rule 144A, but was mandated by Congress (through Section 201(a) of the Jumpstart Our Business Startups Act) to make the change: “We expect the potential benefits of the amendments to Rule 144A to be lower (i.e., less available) for issuers in Rule 144A offerings as compared to issuers in Rule 506(c) offerings because QIBs, which are the only permitted investors in Rule 144A offerings, are generally fewer in number, known by market participants, and better networked than accredited investors. Thus, as we noted in the Proposing Release, we believe that eliminating the prohibition against general solicitation for Rule 144A offerings is unlikely to dramatically increase issuers’ access to QIBs in such offerings or to lower the cost of capital in Rule 144A offerings.” SEC Release No. 33-9415, p. 100.