April 26, 1997 Mr. Jonathan G. Katz Secretary U.S. Securities and Exchange Commission Mail Stop 6-9 450 Fifth Street, N.W. Washington, D.C. 20549 Comments Re: File No. S7-8-97 Offshore Offers and Sales Dear Mr. Katz: I am Joseph B. LaRocco, Attorney at Law, 1055 Washington Boulevard, Stamford, Connecticut 06901. My phone number is (203) 353-1922. My fax number is (203) 353-0323. I have represented clients in many Regulation S and Regulation D offerings. I agree with some of the proposed amendments and feel that new proposals are needed to stop the abusive practices. The most prevalent problem I have encountered however, is not the use of promissory notes, parking schemes, or resales in violation of Reg S, but rather market makers or parties outside the offering process that short the issuer's Common Stock when they get news of Reg S offerings being funded. This problem has soured many relations between issuers and Reg S investors and resulted in needless litigation as well. I have tried to address many of the issues raised in your release for which you have requested comments. My comments are organized according to the headings in you release. I hope they prove helpful. A. Continue Safe Harbor Protection for Equity Sales It seems very clear from the amount of capital being raised that Reg S has proved much more beneficial to issuers and existing shareholders than it has been detrimental. Issuers have raised needed capital for acquisitions, expansion, product research and development, marketing campaigns, working capital, paying down debt and accessing credit lines, to name a few. Assuming the issuer is financially sound, the more strategic and planned the use of the proceeds, the more successful the offering has been in raising funds. Also, the less impact the offering has had on the price of the issuer's Common Stock, and hence existing stockholders. Therefore, it is very important to continue this safe harbor protection. B. Impose New Restrictions on Equity Offerings of Domestic Issuers and of Foreign Issuers Where the Principal Market for the Securities is in the U.S. 1. Longer Restricted Period I do not agree with extending the restricted period from 40 days to two years. A restricted period of 90 or 120 days for reporting issuers would be more effective while the restricted period for non-reporting issuers should remain 1 year. Most Reg S investors require liquidity even though they may hold their securities for a year or more. If the restricted period is extended to 1 or 2 years these investors will either look for Reg D investments with registration rights or require registration rights in all their Reg S investments. The SEC will see a dramatic increase in the number of registration statements being filed. The 2 year restriction will not have the desired effect of these securities being held for 2 years before they flow back into the U.S. It will become more costly for small cap issuers to raise capital because now they will have additional costs associated with filing registration statements. They will be faced with delay damage clauses if the Common Stock is not registered by an agreed upon date. Also, since Reg S investors will not have a definite date upon which they can rely for liquidity, due to the uncertainty of the registration and review process, they will seek greater discounts to earn greater returns on their investment capital and in most situations will get it from the issuer. The smaller market cap issuers (i.e., under $15,000,000) may be unable to raise capital under Reg S even with registration rights. Investors see substantial risk in making an investment with such an issuer where a Form S-3 registration statement is not available. Investors feel the review process will be more stringent and problematic for these issuers, leading to long delays in the registration process. 2. Purchaser Certification The purchaser certifications that are proposed have been in virtually every subscription agreement in which I have been involved, and have included a further representation that "...the sale has not been prearranged with a purchaser in the United States." I strongly agree with this certification requirement and would also add language for certification to be made by the issuer as well. I suggest that the following two issuer certifications or representations be required: "Offshore Transaction. Issuer has not offered the securities to any person in the United States or to any U.S. person or for the account or benefit of any U.S. person. At the time the buy order was originated, issuer and/or its agent reasonably believed that purchaser was outside of the United States and was not a U.S. Person as defined in Regulation S. Issuer and/or its agent reasonably believe that the transaction has not been prearranged with a purchaser in the United States. No Directed Selling Efforts. In regard to this transaction, issuer has not conducted any "directed selling efforts" as that term is defined in Rule 902 of Regulation S nor has Issuer conducted any general solicitation relating to the offer and sale of the securities to U.S. persons residing within the United States or elsewhere." 3. Purchaser and Distributor Agreements The proposal that resale and hedging restrictions be set forth in agreements will add further assurance of Reg S compliance. Most, if not all, of the transactions in which I have been involved have included similar language. 4. Legended Certificates I strongly agree with this proposal and the idea of making the legend more specific, including the use of anti-hedging language. 5. Stop Transfer Instructions The proposal requiring an issuer, by contract or otherwise, to refuse to register any transfer of securities unless made in accordance with the registration or exemptive provisions of the Securities Act of 1933 (the "Securities Act"), or in accordance with Regulation S seems harsh. Is this refusal to register any such transfer meant to be indefinite or only temporary? If it is meant to be indefinite, it could mean a complete loss of the funds invested by the investor, regardless of whether the offending act was intentional or merely negligent. 6. Request for Comment on New Requirements As I mentioned, the extended time period alone will force most offerings to Reg D with registration rights or Reg S with registration rights. If that happens and the 8-K filing requirement is abandoned, then from the non-U.S. investor's perspective, it won't matter if the offering is done under Reg D or Reg S. This is why I feel a 90 or 120 day restricted period would be more effective. Issuers will still be able to raise capital through Reg S and the flow back period will be longer. In approximately one-half of the Reg S offerings in which I have been involved, the restricted period has been staggered. One example is a convertible preferred issued with 50% convertible after 45 days and 50% convertible after 90 days. Another example is a convertible debenture issued with 25% convertible after 60 days, 25% after 90 days, 25% after 120 days and 25% after 150 days. A staggered restricted period is beneficial since it provides an orderly flow-back and seems to provide more price stability which protects existing stock holders. Also, outsiders that are following Form 8-K filings with the intention of shorting will find it much more difficult to short an issuer's Common Stock when there is a staggered time period. One fact that cannot be avoided however, is that issuers raising capital through Reg S or Reg D equity sales must consider dilution. Issuers that fail to recognize this dilution factor and the effect it will have on the price of their stock should not make Reg S and Reg D investors the scapegoat. 7. Elimination of Form 8-K Filing Requirement If the restricted period is extended to 90 days or later, then the 8-K filing requirement should be eliminated and only quarterly reporting should be required. This would be comparable to the quarterly reporting required for Reg D offerings. Many issuers and Reg S investors feel that more shorting is occurring because others have easy access to Form 8-K filings via EDGAR. C. Revise Category 3 to Prohibit Payments with Promissory Notes. The use of Promissory Notes should be strictly prohibited in any Reg S offerings. It is totally contrary to what I understand to be the intent and reason behind the adoption of Reg S. There doesn't seem to be any real investment intent or market risk in such a transaction. D. Classify Domestic Equity Securities, and Foreign Equity Securities where the Principal Market for the Securities is in the United States, as "Restricted Securities" Your question in this section concerning integrating Reg S and Reg D requirements has been generally discussed by me in Section B, subsection 1. If the restricted period is extended beyond 90 or 120 days or Reg S securities are categorized as "restricted securities" then I would say it absolutely makes sense to combine Reg S and Reg D. E. Application of Proposed Changes 1. Foreign Companies where the Principal Market for the Securities is in the United States. Domestic companies and foreign companies with their principal market in the United States should be subject to the same proposed Reg S changes since indirect distributions and resales are equally likely for both. I agree with your definition of "principal market in the United States" but would decrease the time period for examining such sales to 180 days prior to the closing of the Reg S offering. I suggest a 45 day restricted period for resales of domestic or foreign issuer's securities that are listed on a "designated offshore securities market", even if they have a "principal market in the United States", as long as their Reg S resales occur in a "designated offshore securities market". In that situation, I would also require that the domestic or foreign issuer be responsible for policing such sales and require an appropriate legend and stop transfer instruction be used. This will provide better protection against flow back than an offering conducted by a domestic or foreign issuer not having a "principal market in the United States" since you are not restricting that issuer's Reg S securities from being entirely sold back into the United States market. As a side note, in your definition of "designated offshore securities market", I would add the Berlin Stock Exchange. 2. Equity Securities I don't really see a reason for making a distinction in the new rules between debt or equity offerings. Most transactions in which I have been involved have been based on the issuer's choice of going with debt or equity. I strongly disagree with imposing Category 3 restrictions on convertible or exchangeable securities or warrants of domestic issuers, and of foreign issuers where the principal market for the underlying equity securities is in the United States. Such a move would clearly create a big move toward Reg D offerings with registration rights or at least Reg S with registration rights. Whether it is a convertible security or straight Common Stock either one is equally likely to result in an unregistered distribution of equity securities in the United States so I don't see any reason for limiting the use of convertible securities. F. Other Possible Restrictions 1. Hedging Purchasers should not be allowed to shift the economic risk of a transaction through short sales, swaps or derivative securities transactions. It is hard to find investment intent when such actions are taken by a purchaser. I think that the legends and purchaser and distributor agreements are the best protection, unless you can actually find out who has been shorting a stock. To some extent, the Reg S field has become self-regulating. Once there is a strong suspicion that a particular purchaser is shorting, the issuer will temporarily prevent sales of its Common Stock by that purchaser either by refusing to remove the legend, or if the legend has already been removed, putting that purchaser on notice and placing a stop transfer restriction on such shares. Also, news usually spreads among the distributors and the investment banking community concerning which purchasers have been suspected of shorting in previous Reg S offerings. These purchasers, right or wrong, are being shown very few offerings. Unfortunately, no one seems to be able to find out through NASDAQ or otherwise exactly who is shorting an issuer's Common Stock and this makes the hedging issue very difficult to handle. I don't think having separate hedging restrictions for equity securities, large issuers or convertible securities or putting a cap on a permissible amount of hedging is a good idea. In all those situations a purchaser would still be hard pressed to prove a bonafide investment intent, even if the shorting was done in a "designated offshore securities market". I would be very surprised if any issuers would agree to any shorting provisions. 2. Discounts Discounted offers should not be excluded from the Regulation S safe harbor. Also, I think it would be unwise to set a cap on discounts because the investment banking community and simple supply and demand seem to dictate what discounts, coupon rates and dividends will be structured into any given Reg S offering. Reg D offerings have no such restrictions, so why should Reg S, especially in light of the proposed extension of the restricted period. There are numerous factors taken into consideration by the issuer, distributor and purchaser before agreeing on the final offering terms. They include market cap, trading volume or liquidity, shares authorized, shares issued and outstanding, use of proceeds, size of the offering and, most importantly, the issuer's financials. No two issuers are exactly the same. GENERAL COMMENTS Concerning your non-substantive technical and clarifying revisions, I think revising the safe harbor sections as "category 1", "category 2" and "category 3" and stating clearly what procedures are to be followed and what securities are eligible for each category will help make the rule more readable and understandable. If Reg S securities are not categorized as "restricted securities", which I truly hope is the case, but rather the restricted period is merely extended, then why not clearly state when the securities can be sold in the United States. As I'm sure you are aware, there have been differing opinions and much confusion on this issue. The time has come for clarification. Sincerely, Joseph B. LaRocco