Fixing Reg S - SEC closes up loopholes. . .
This is one safe harbor with too many pirates in it. We intend to sweep it clear.'' With those words, Securities and Exchange Commission Chairman Arthur Levitt last week outlined a major reform of Regulation S, the rule that allows U.S. companies to sell stock to foreigners without telling their shareholders.
To Barron's, Reg S seemed like ``Offshore Madness,'' and that's exactly what we called it in our April 29 cover story. The 1990 securities amendment was intended to help American companies tap the global capital markets, but it quickly became a tool for scamsters. Offshore investors would buy Reg S shares at discounts as deep as 50% and then, after waiting the required 40 days, sell the shares back into the U.S. at full price.
It was a guaranteed windfall for the offshore folks and a guaranteed losing proposition for unsuspecting U.S. investors, who saw the value of their shares mysteriously erode as the flood of offshore shares came back into the States and depressed prices.
Some Reg S investors bought shares offshore and then sold an equal number short in the U.S., thereby locking in their profits. In another tricky maneuver, offshore investors could buy their Reg S shares not with cash but with promissory notes that didn't have to be repaid for months and sometimes years. In other words, the offshore anglers could make lush profits without putting up a dime.
Last week, in a long-overdue recognition of Reg S's failings, the SEC voted unanimously to accept reform recommendations. A key provision of the reform requires companies to disclose a Reg S sale within 15 days. Another change removes a big incentive to use Reg S shares to raise capital for acquisitions. Currently, companies must furnish potential U.S. investors with audited financial statements of the targeted company. Under Reg S, companies could use private placements and offshore sales without revealing their merger intentions or the target's books.
The new rule requires audited statements if the targeted company's assets are greater than 50% of the acquiring company's. Both rules will take effect in November, 30 days after publication in the Federal Register.
Expect more Reg S reforms later this year. Most likely, the 40-day holding period will be expanded, and the use of short-sales and promissory notes will be curtailed.
Declares Brian Lane, the SEC's new head of corporate finance, ``We want to put everyone on official notice that we are serious about going after Reg S abuses.''
- Jaye Scholl
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