Selling Private Securities To Foreign Investors

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A client recently asked whether a foreign (i.e., non-U.S.) person could invest in private securities offered by a United States domestic issuer (such as a Texas limited liability company).  In this context, “private” securities are securities sold and issued to an investor under an exemption from the registration requirement of the Securities Act of 1933, as amended (the “Securities Act”).  Private securities are contrasted with “public” securities that are registered with the SEC and freely-tradable in a public market, like the Nasdaq stock exchange.

The exemption most frequently used by my clients to sell securities to US investors is Rule 506 of Regulation D under the Securities Act, that allows a company to sell its private securities on a largely unrestricted basis provided that the company is selling the securities solely to “accredited” investors.  This is relevant because the question about the foreign investor always comes from a client who already is conducting an offering of their securities to US investors.  There are other exemptions than Rule 506 that my clients might use, but for purposes of this article, we are going to assume that my client already is conducting a sale of its Texas LLC interests to investors residing in the United States (mostly in Texas) under Rule 506 (and this could either be Rule 506(b) with no advertising/general solicitation, or Rule 506(c) which allows advertising).

Regulation S is an additional set of rules promulgated by the SEC under the Securities Act that provides for a separate exclusion from the registration requirements of the Securities Act for offerings by a US issuer to foreign investors (like my Texas LLC client described above who wants to sell some of its interests to an investor from Mexico).  The basic requirements of Regulation S are that the offering must be made in an “offshore transaction” and that no “directed selling efforts” to US investors may be made by the issuer.

To be an “offshore transaction”, no offer may be made to any person in the United States.  Further, at the time the investor wires their money to purchase the securities, the investor must be (or must be reasonably believed by the issuer to be) physically outside the United States.

The term “directed selling efforts” is defined as “any activity undertaken for the purpose of, or that could be reasonably expected to result in, conditioning the U.S. market for the relevant securities.”  Very basically, the issuer may not advertise the Regulation S offering in places where the advertising will reach persons in the United States, and then turn around and rely on Rule 506 to sell the same securities to the US persons.  At the time that Regulation S was adopted, of course, no advertising or general solicitation was permitted for Rule 506 offerings, but now of course, the new Rule 506(c) exemption in fact permits general solicitations and advertising.

To comply with Regulation S contractually, my client must require the investor from Mexico to certify that the investor is not a U.S. person and the investor is not acquiring the securities for the account or benefit of any U.S. person.  Additionally, the foreign investor must agree not to resell the securities other than in accordance with applicable U.S. securities laws.  Finally, they must agree not to engage in hedging transactions with regard to such securities unless in compliance with the Securities Act.

The foregoing description vastly over-simplifies ALL of the requirements of Regulation S, but is accurate for the specific facts described above.  In many ways, compliance with Regulation S is easier than compliance with Regulation D because there is no requirement that the foreign investor be “accredited”.  The other requirements can be satisfied by imposing restrictions on transferability that my clients would include in their offering documents in any event.

An important legal question that should be considered by my client taking money from a foreign investor is anti-money laundering (AML) compliance.  Unless my client is an investment adviser, though, the burden for AML compliance will largely rest on the shoulders of the bank where my client has their account.  If the investor is allowed to wire the money to my client’s account, that means that the transfer of funds has cleared the bank’s AML compliance requirements, and my client should be in the clear.  This will be the case unless my client has specific knowledge that the investment proceeds are derived from illegal means.