Regulation S for Canadian Issuers

Nick Wright, BA, JD, MBA, LLM (Tax)
Wright Business Law

Canadian companies and private investment funds increasingly raise capital from investors in multiple jurisdictions. A financing may involve investors in Canada, the United States and other countries, with different securities law requirements applying to each part of the offering.

For a Canadian issuer, compliance with National Instrument 45-106 Prospectus Exemptions (NI 45-106) does not by itself address U.S. federal securities law. Where securities are offered and sold outside the United States, Regulation S under the U.S. Securities Act of 1933 can provide an important safe harbour from the registration requirements of the U.S. Securities Act.

Regulation S is particularly relevant to Canadian issuers conducting cross-border private placements. An issuer may, for example, rely on a prospectus exemption under NI 45-106 for Canadian distributions, Regulation D for qualifying U.S. offers and sales, and Regulation S for qualifying offshore offers and sales.

This article examines the principal requirements of Regulation S, its interaction with Canadian private placement rules, and practical considerations for Canadian issuers conducting cross-border offerings.

What Is Regulation S?

Section 5 of the U.S. Securities Act generally requires offers and sales of securities to be registered with the U.S. Securities and Exchange Commission unless an exemption or other exclusion from registration is available.

Rule 901 establishes the general principle that, for purposes of section 5 of the U.S. Securities Act, the relevant statutory terms relating to offers and sales are deemed not to include offers and sales that occur outside the United States. Rules 903 and 904 provide non-exclusive safe harbours for determining when specified offers, sales and resales are deemed to occur outside the United States.

Rule 903 provides the principal safe harbour for offers and sales by an issuer, a distributor, their respective affiliates and persons acting on their behalf. Rule 904 provides a separate safe harbour for certain offshore resales by persons other than the issuer, a distributor, specified affiliates and persons acting on their behalf.

For a Canadian company or private fund issuing securities directly to offshore investors, Rule 903 will generally be the principal Regulation S safe harbour considered.

Regulation S addresses U.S. federal securities registration requirements. It does not provide an exemption from Canadian securities law or from the securities laws of the jurisdiction in which an offshore purchaser is located. A Canadian issuer conducting an international financing may therefore need to satisfy several securities law regimes in the same offering.

The Core Requirements of Regulation S

Under Rule 903, an offer or sale by an issuer or other person within the rule is deemed to occur outside the United States if the transaction satisfies the applicable conditions.

Two conditions are fundamental: the offer or sale must be made in an “offshore transaction,” and there must be no “directed selling efforts” in the United States by the issuer, a distributor, their respective affiliates or persons acting on their behalf.

Additional conditions apply depending on the category into which the securities fall under Rule 903.

Offshore Transaction

Rule 902(h) defines when an offer or sale qualifies as an offshore transaction.

The offer must not be made to a person in the United States. In addition, subject to specified provisions for transactions through qualifying offshore markets, either the purchaser must be outside the United States when the buy order originates or the seller and any person acting on its behalf must reasonably believe that the purchaser is outside the United States at that time.

This makes the circumstances surrounding the offer and the origination of the purchase order important.

The analysis should also be distinguished from the separate definition of “U.S. person” under Rule 902(k). Residence, physical location and U.S. person status can each be relevant under Regulation S, but they are not interchangeable concepts.

For example, a Canadian issuer should not rely solely on a purchaser’s Canadian citizenship or Canadian mailing address when determining whether an offer and sale satisfy the offshore transaction requirement. The issuer should establish reasonable subscription and closing procedures designed to support the factual basis for reliance on Regulation S.

No Directed Selling Efforts

Rule 902(c) defines “directed selling efforts” generally as activities undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States for securities being offered in reliance on Regulation S.

The prohibition applies to the issuer, distributors, their respective affiliates and persons acting on their behalf.

Directed selling efforts can include certain advertising and promotional activity relating to the offering. Regulation S also contains specified exclusions from the definition for particular activities.

The practical issue for a Canadian issuer is that the Regulation S analysis extends beyond where the issuer is incorporated or where its management is located. The issuer should consider how the offering is marketed, who receives the marketing materials, where prospective investors are located and what activities are undertaken by dealers, finders, placement agents and other persons acting on the issuer’s behalf.

Online Marketing and Cross-Border Offerings

Digital fundraising can make the directed selling efforts analysis particularly important.

Consider an Ontario private fund that advertises an offering online, distributes investor presentations electronically, conducts virtual presentations and accepts subscriptions through an online portal. The fact that these activities originate in Canada does not, by itself, establish compliance with Regulation S.

The issuer should consider whether its website, social media activity, email campaigns, online advertising and investor presentations could reasonably be expected to condition the U.S. market for the securities being offered in reliance on Regulation S.

The appropriate procedures will depend on the offering. They may include controls over investor distribution lists, geographic targeting, investor qualification procedures, legends or notices, and separate processes for investors being solicited under a U.S. exemption.

The activities of intermediaries should also be considered. A Canadian issuer relying on Regulation S should understand how dealers, finders and placement agents are identifying and communicating with prospective investors.

These issues are generally easier to address before marketing begins than after prospective investors have already been solicited.

The Regulation S Categories

Satisfying the offshore transaction and directed selling efforts conditions is only part of the Rule 903 analysis. Rule 903 establishes three categories of securities, with additional conditions based generally on the risk that securities sold offshore may flow back into the United States.

The category analysis depends in part on the issuer’s status under Regulation S and the characteristics of the securities being offered. Canadian incorporation does not, by itself, determine whether an issuer is a “foreign issuer” for Regulation S purposes. The applicable Regulation S definitions should therefore be considered before determining the relevant Rule 903 category.

Category 1

Category 1 applies to specified transactions considered to present relatively low risk of flowback into the United States.

Where Category 1 applies, no conditions beyond the general requirements in Rule 903(a) apply. Eligibility depends on the issuer, the securities being offered and the circumstances specified in Rule 903.

For a foreign issuer, Category 1 may be available where there is no “substantial U.S. market interest” in the relevant securities, as defined in Regulation S, or in certain “overseas directed offerings” conducted in accordance with Rule 903.

Category 2

Category 2 applies to specified securities that do not qualify for Category 1, including equity securities of reporting foreign issuers and debt securities of reporting issuers or non-reporting foreign issuers. Additional requirements include “offering restrictions” and a 40-day distribution compliance period, together with restrictions prescribed by Rule 903(b)(2).

Category 3

Category 3 is the residual category for securities that do not qualify for Categories 1 or 2.

It generally carries more extensive conditions. Depending on whether the securities are debt or equity securities and the circumstances of the offering, these can include offering restrictions, distribution compliance periods, purchaser certifications and agreements, legends and transfer restrictions.

The applicable category should be determined before the issuer finalizes its offering documents, subscription agreement and closing procedures. The category can materially affect how the offshore offering must be conducted and how securities can subsequently be transferred.

Regulation S and Canadian Private Placements

Regulation S does not replace the Canadian securities law analysis.

Where a Canadian issuer distributes securities in Ontario, the issuer must determine whether the distribution is made under an available prospectus exemption under NI 45-106 or other applicable Ontario securities law.

Depending on the issuer and purchaser, commonly used exemptions may include the accredited investor exemption, offering memorandum exemption and, where its conditions are satisfied, the private issuer exemption.

The issuer must also consider whether a Form 45-106F1 Report of Exempt Distribution is required and whether registration requirements under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations apply to the issuer or any person involved in the distribution.

A cross-border financing therefore requires separate but coordinated analyses.

For Canadian securities law purposes, the issuer determines where a distribution occurs, which prospectus exemption is available, whether registration requirements are engaged, what filings are required and what Canadian resale restrictions apply.

For U.S. federal securities law purposes, the issuer separately considers whether an offshore offer or sale falls within Regulation S or whether registration or another available exemption or safe harbour is required.

For investors in other countries, the securities laws of the purchaser’s jurisdiction must also be considered.

Using Regulation S and Regulation D in the Same Offering

A Canadian issuer may conduct a financing involving both U.S. and offshore investors.

Regulation S can be used concurrently with a registered or exempt U.S. offering. Rule 152(b)(2) provides a non-integration safe harbour for offers and sales made in compliance with Regulation S. Accordingly, a Canadian issuer may structure different portions of a financing under different securities law regimes.

For example, an offering might involve:

• Canadian investors purchasing under an applicable NI 45-106 prospectus exemption;
• U.S. investors purchasing in reliance on Rule 506(b) or Rule 506(c) of Regulation D, where its requirements are satisfied; and
• other offshore investors purchasing in transactions structured to comply with Regulation S and the applicable securities laws of their respective jurisdictions.

The documentation should reflect these distinctions.

Regulation D and Regulation S purchasers may require different representations, legends, transfer restrictions and closing procedures. The issuer should also consider how marketing for one part of the offering interacts with the requirements applicable to another part.

This is particularly important where the U.S. portion relies on Rule 506(b), which generally prohibits general solicitation, rather than Rule 506(c), which permits general solicitation subject to its conditions.

These issues require particular attention where the same PPM, investor presentation, website or subscription process is used across several jurisdictions.

The objective should be a coordinated offering structure in which each category of investor is identified and the applicable securities law requirements are addressed before the investor is accepted.

Subscription Agreement Representations

Subscription documentation is an important part of establishing the factual basis for reliance on Regulation S.

The appropriate representations depend on the offering and the applicable Rule 903 category. They may address:

• the purchaser’s location outside the United States;
• the location at which the buy order or subscription originated;
• whether the purchaser is a “U.S. person” within Rule 902(k), where relevant;
• whether the securities are being acquired for the account or benefit of a U.S. person, where relevant;
• the circumstances in which the purchaser received the offering materials;
• compliance with applicable distribution compliance periods;
• applicable restrictions on resale or transfer;
• the securities laws applicable in the purchaser’s jurisdiction; and
• any certifications or agreements required by the applicable Rule 903 category.

Where the purchaser is an entity, trust, intermediary or nominee, additional information may be necessary to determine the relevant purchaser status and the account for which the securities are being acquired.

Subscription representations should support the underlying transaction. They are evidence of the circumstances on which the issuer relies. Standard representations cannot correct solicitation or sales activity that does not satisfy the substantive requirements of Regulation S.

Issuers should therefore maintain appropriate records supporting their Regulation S analysis and the basis on which each offshore subscription was accepted.

Resale Restrictions and Distribution Compliance Periods

Securities sold in reliance on Regulation S should not automatically be assumed to be freely tradeable immediately after closing.

Depending on the issuer, securities and applicable Rule 903 category, a distribution compliance period and additional offering restrictions may apply. Regulation S can also require legends, purchaser certifications, contractual restrictions and other measures intended to restrict impermissible flowback into the United States.

Rule 904 provides a separate safe harbour for certain offshore resales by persons other than the issuer, a distributor, specified affiliates and persons acting on their behalf, subject to the conditions of that rule.

Canadian securities law must be considered separately.

Where securities are distributed under a Canadian prospectus exemption, National Instrument 45-102 Resale of Securities may impose a restricted period, seasoning period or other conditions on subsequent trades, depending on the issuer, exemption and circumstances.

An issuer and its investors should therefore consider both U.S. and Canadian resale requirements before assuming that securities can be transferred following the original private placement.

Common Regulation S Mistakes

Cross-border offerings can create compliance problems where Regulation S is treated simply as an exemption for non-U.S. investors.

Common issues include:

• assuming that incorporation in Canada automatically places an offering outside U.S. securities law;
• treating citizenship, residence, mailing address and physical location as interchangeable concepts;
• failing to establish the circumstances in which the purchaser’s buy order originated;
• conducting marketing that constitutes directed selling efforts in the United States;
• failing to consider websites, social media, digital advertising and virtual investor presentations;
• using identical Regulation D and Regulation S purchaser representations without considering the requirements applicable to each;
• failing to determine the applicable Rule 903 category;
• overlooking applicable offering restrictions, distribution compliance periods, legends or purchaser agreements;
• failing to consider the activities of dealers, finders and placement agents;
• treating Regulation S as satisfying the securities laws of the purchaser’s home jurisdiction; and
• failing to coordinate U.S. securities law compliance with NI 45-106, NI 31-103 and applicable Canadian filing requirements.

A cross-border offering should therefore be structured before active solicitation begins.

Practical Compliance Checklist

Canadian issuers planning a cross-border private placement should consider the following:

• identify the jurisdictions in which offers and sales are expected to occur;
• determine the applicable Canadian prospectus exemption for Canadian distributions;
• determine whether Regulation S is available for the intended offshore transactions;
• confirm that the relevant offers and sales satisfy the offshore transaction requirement;
• establish procedures designed to prevent directed selling efforts in the United States;
• determine the applicable Rule 903 category;
• identify any applicable offering restrictions and distribution compliance period;
• prepare Regulation S purchaser representations appropriate to the transaction;
• coordinate Regulation S documentation with any Regulation D portion of the financing;
• review websites, social media, email campaigns, investor presentations and subscription portals;
• address the activities of dealers, finders and placement agents;
• determine applicable Canadian, U.S. and other foreign resale restrictions;
• complete Form 45-106F1 and other required Canadian regulatory filings where applicable; and
• maintain records supporting reliance on the applicable prospectus exemptions and U.S. safe harbours.

Conclusion & Next Steps

Regulation S can be an important part of the securities law framework for Canadian companies and private investment funds raising capital internationally.

Its application should be considered when the offering is structured. The location and status of investors, manner of solicitation, applicable Rule 903 category, subscription documentation and resale restrictions can all affect whether an offshore offering falls within the Regulation S safe harbour.

For a multi-jurisdictional financing, Regulation S is only one part of the analysis. Canadian distributions remain subject to applicable Canadian prospectus and registration requirements. Offers and sales to U.S. investors may require registration or reliance on Regulation D or another available exemption. Offers and sales in other countries may also engage the securities laws of those jurisdictions.

Canadian issuers conducting cross-border private placements should therefore coordinate the Canadian, U.S. and other offshore portions of the financing and ensure that their marketing practices, offering documents, subscription agreements and closing procedures reflect the requirements applicable to each investor group.

Book a Consultation

If you are a Canadian issuer or private investment fund planning a cross-border private placement, contact us to schedule an initial consultation with Nick Wright.