Accessing US institutional investors on an international IPO

Structuring the offer

Registration under the Securities Act¹

In order to extend an offering into the United States it must either be registered with the US Securities and Exchange Commission (the SEC) under the US Securities Act of 1933, as amended (the Securities Act), or, alternatively, structured to comply with one or more exemptions from registration.

In practice, cost and other considerations typically make Securities Act registration unattractive for companies whose shares will not be traded on an exchange in the United States.² This briefing therefore focuses on a well-established structure commonly referred to as a Rule 144A/Reg S offering or a Reg S offering with a Rule 144A tranche. This involves relying on a combination of two exemptions from registration under the Securities Act to allow the IPO shares to be offered:

• Outside the United States under Regulation S which establishes a safe harbour for the offer and sale of securities made in an “offshore transaction” provided that certain other conditions are met including there being no “directed selling efforts” (in summary, activities undertaken for the purpose of, or that could reasonably be expected to have the effect of, conditioning the market in the United States – e.g. placing an advertisement referring to the offering in a newspaper with a general circulation in the United States).³
• To large US investors known as qualified institutional buyers (QIBs) in the United States under the safe harbour for resales under Rule 144A.⁴ Reliance on Rule 144A is subject to certain conditions being met, including (in summary) that the securities being offered are not listed on a US exchange and that certain information is made available to investors. It is also market practice to ensure that there is no “general solicitation” or “general advertising” of the securities in the United States while the offering is being made.

Under a Rule 144A/Reg S structure, the company, acting through its underwriters, will seek to sell a meaningful proportion of the shares to QIBs in the United States through a relatively widely marketed US institutional offering usually involving an institutional roadshow. QIBs will be required to make their investment decision based solely on the information contained in a prospectus or international offering circular – i.e. without the opportunity to do the additional due diligence typically associated with a US private placement. Concurrently, offers and sales of the shares will be made in the customary manner in the company’s chosen market of listing and elsewhere outside of the United States in reliance on Regulation S.

This approach enables the company to raise capital from the largest institutional investors in the United States, thereby potentially optimising its capital-raising efforts, without actually conducting a public offering, or becoming a public reporting company, in the United States.⁵

However, as discussed further below, even where the offer is exempt from registration under the Securities Act, certain steps must be taken in order to manage the risk of US liability.

Liability for misstatements and omissions

Extending the offering into the United States introduces potential liability for material misstatements and omissions in the offering materials under various federal and state securities anti-fraud laws, including in particular Section 10(b) of the US Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10b-5 under the Exchange Act, which (among other things) prohibit material misstatements and omissions by certain persons, including the company and its underwriters,⁶ in connection with an offering.

Although regimes applicable to IPOs in virtually all jurisdictions will prohibit material misstatements or omissions, as a practical matter US investors and regulators have historically been more likely to pursue securities law claims or otherwise seek compensation from the company, its senior management, directors, underwriters and others. Consequently, this risk is taken very seriously in the context of extending a non-US IPO to QIBs in the United States.

In this context, the offering will be structured to comply with a well-developed set of market practices (collectively referred to as “establishing a due diligence defense”) which are intended to make it less likely that the offering materials will contain misstatements or omissions and to make it difficult for a plaintiff to establish the intent to defraud/reckless disregard for the truth by underwriters and certain other potential defendants which is one of the elements generally required for a successful claim.⁷

As part of this exercise, underwriters will typically require, among other documents to be delivered and procedures to be performed, the provision of “Rule 10b-5 disclosure letters” from both their own and the company’s US counsel. This is a form of negative assurance letter that tracks the relevant language in Rule 10b-5 and, as such, gives comfort that the offering documents do not make any “untrue statement of material fact or omit to state a material fact necessary in order to make the statements made therein, in the light of the circumstances under which they were made, not misleading”. In order to provide these disclosure letters, it will be necessary for the IPO prospectus or international offering circular to be drafted (broadly speaking) to US disclosure standards which may involve including additional disclosures over and above those required by domestic rules in the market where the company is listing.

Implications of including a Rule 144A tranche

Although including a Rule 144A tranche on an international IPO is well trodden path, it has the potential to impact the execution of the transaction in a number of ways. How significant this is in practical terms will depend on the divergence between the US-style approach and that otherwise typically taken in the company’s market of listing. Where a Rule 144A component is envisaged, it will be key to involve US counsel from the outset to ensure that the offer structure, documentation and process comply with applicable US requirements and market practice. Failure to do so may result in delays to the timetable and (in some cases) exemptions from registration under the Securities Act being unavailable.

In the following sections of this briefing, we discuss some of the common areas where differences can often arise between US and domestic practice. Our answers address practice generically, rather than focusing on a comparison with a specific non-US market or market(s). As such they are necessarily illustrative because the complete answers/precise impact will ultimately vary based on domestic regulation and market practice in the jurisdiction where the company is seeking a listing. However, if you would like to discuss any of these issues in further detail (including in the context of your company’s specific circumstances) or are interested in receiving further information on particular markets, please do not hesitate to get in touch.

Due diligence on deals involving a Rule 144A component

How is the approach to documentary legal due diligence impacted?

In almost any IPO a detailed legal due diligence exercise will be conducted by the company’s counsel (and/or, in some cases, the underwriters’ counsel). In many jurisdictions, market practice is to document the output of this exercise in the form of a detailed, written report which is produced by the company’s counsel and reviewed by underwriters’ counsel.

However, where a Rule 144A tranche is included, it is usual in many markets for the underwriters to receive and rely on Rule 10b-5 disclosure letters (as discussed above) – typically instead of a written due diligence report being produced. These letters will be required both from the underwriters’ own counsel and from the company’s counsel and, therefore, each law firm will insist on conducting the underlying legal due diligence itself, resulting in a parallel exercise rather than one firm relying on or reviewing the work of the other.

In terms of the underlying documentation requested and reviewed, this will essentially encompass all of the documents that would be included if the deal involved a US IPO. Depending on market practice/regulatory requirements in the jurisdiction of listing, this may significantly expand the scope of the exercise compared to a purely domestic IPO.

What approach is taken to management and financial due diligence?

The Rule 10b-5 due diligence exercise discussed above typically includes (in addition to documentary diligence) formal management and accounting due diligence meetings at which the company’s management team present the business and give the advisers and underwriters the opportunity to ask questions and test statements being made in the prospectus/offering circular. “Bring down” calls and sessions will also be scheduled at key points in the transaction process to update this exercise. Increasingly, similar practice is followed on international IPOs whether or not there is a Rule 144A tranche to the offering.

US counsel (and, typically, the underwriters) will also participate in drafting sessions on the prospectus/offering circular alongside members of the company’s management team. This provides an opportunity to discuss the material statements being made (as well as any potential omissions) in order to test them for accuracy and completeness.

Will a formal written verification exercise be carried out?

In some jurisdictions it is market practice for the company’s counsel to prepare detailed written verification notes intended to ensure that material statements made in the prospectus/offering circular and other marketing documents are supported by written or documentary evidence. This is not the case for an IPO in the United States, although great care will still be taken to ensure the accuracy of all information in the public documentation.  Where a Rule 144A tranche is included in the offer, the written verification notes will likely relate to only the most significant statements made.

The drafting of the prospectus/offering circular will also (as mentioned above) be tested in the context of discussions at drafting meetings and the underwriters will receive different forms of comfort on its completeness and accuracy (as discussed in the section below on the underwriting agreement and comfort package).

Key disclosure considerations where a Rule 144A tranche is included

Will additional disclosure requirements apply to the prospectus/offering circular?

As mentioned above, in order to enable 10b-5 disclosure letters to be provided, the prospectus will generally be drafted to meet US disclosure standards (subject to established market practice exceptions). How much of an impact this has in practice will depend on the difference between US disclosure requirements and those that apply in the jurisdiction where the company is listing. However, there are a number of areas where additional disclosure (over and above local requirements) is commonly required, including the following:

• More specific risk factors drafted to US standards.
• An additional or expanded operating and financial review (OFR) (also referred to management’s discussion and analysis of financial condition and results of operations or MD&A) which addresses SEC guidance and requirements and US market practice.
• Certain requirements in the context of financial information (as discussed further below).
• Often a somewhat more detailed business section – but in any event this section will be drafted with an eye towards potential US liability.
• US tax disclosures, customary selling restrictions/disclaimers and certain representations and warranties that QIBs will be deemed to have made by purchasing shares.
• In the case of certain industries (e.g. banking) detailed US-style statistical disclosures may need to be considered/included if a suitable equivalent is not required under domestic rules.
• Disclosures about the economic, political, regulatory and industry conditions in the principal jurisdictions where the group’s business is conducted.

Where the domestic prospectus/offering circular is drafted in English these disclosures can either be included directly in that document or be covered off in part in a “wrapper” that is attached when it is sent to QIBs and to other international investors outside the United States.

Where the document is drafted in another language, it is usual practice to produce a separate international offering circular which includes substantially the same information as the domestic prospectus/offering circular (or a verbatim translation) alongside the additional disclosures.

What are the key requirements in relation to financial information?

A detailed discussion of the SEC’s requirements in relation to financial statements is beyond the scope of this briefing, however there are a few points that are generally applicable where a non-US IPO is being extended to QIBs in the United States:

• Reporting standards: It is not necessary to prepare US GAAP financial statements or to “reconcile” the company’s IFRS or other GAAP financial statements to US GAAP. IFRS (as adopted by the IASB) can be used by foreign private issuers in the United States and IFRS (more generally) is accepted in Rule 144A offering documents. Where a national or other set of accounting principles is used, a qualitative discussion of any significant differences between those accounting standards as they are applied by the company and IFRS or US GAAP is typically included rather than a formal reconciliation being produced.
• Period covered by the financial information: The requirement (common in many non-US jurisdictions) to include three years of audited information satisfies a similar US requirement. In fact, in some cases (e.g. “emerging growth companies”) the US requirements can be lighter touch and require only two years of audited financial statements.
• Interims: Issues can sometimes arise in relation to interim financial statements. For example, where interims are included in the prospectus/offering circular, Rule 10b-5 will typically mean that comparative statements for the prior interim period also need to be disclosed in order to facilitate preparation of the OFR/MD&A. This may not be the case under domestic rules in the company’s jurisdiction of listing.
• Age of latest information: As a practical matter, from a US perspective it will generally be necessary to include financial statements with a balance sheet (audited or reviewed) as of a date that is less than 135 days prior to closing of the offer. This requirement is driven by auditor and underwriter market practice rather than SEC rules. It can often mean that more recent audited/reviewed information is needed than is technically required under the domestic rules in the company’s jurisdiction of listing.
• Significant acquisitions: Where the company has made a significant acquisition during the period covered by the financial information, there may be mismatches between the additional financial information required under the US and domestic rules and differences as to the extent of pro forma financial information that is needed.

Do US rules impact the ability to include forward-looking statements in the prospectus/offering circular?

The SEC has consistently supported the inclusion of forward-looking information such as financial projections and strategic outlooks in US prospectuses, provided that the statements are made in good faith, have a reasonable basis, and are accompanied by meaningful cautionary language.

That said, US issuers remain cautious about including forward-looking statements in their prospectuses because of the heightened litigation risk if they prove to be incorrect (given the plaintiff will inevitably have the benefit of 20/20 hindsight). This caution is also seen in the context of Rule 144A offerings, notwithstanding that QIBs are routinely deemed to be sophisticated enough to understand and be provided with such information in the context of other securities transactions in the United States (for example, private investment in public equity (or PIPE) deals).

Consequently, forward-looking statements are used sparingly on deals with a Rule 144A tranche, and great care is taken where they are included. The practical impact of this will ultimately depend on the extent to which, in the company’s market of listing, it is market practice to include more extensive forward-looking information. This varies widely between different jurisdictions but, in those where it is market practice to include forward-looking information from a domestic perspective, this will need to be considered in light of US liability concerns which will likely (as a practical matter) restrict the extent and content of such disclosures.

The underwriting agreement and comfort package on deals with a Rule 144A tranche

How is the underwriting agreement impacted?

Given normal market practice on international offerings, in many cases changes to the underwriting agreement required to accommodate a Rule 144A tranche should not generally be extensive. They will primarily involve the inclusion of additional representations, warranties and covenants intended to ensure the availability of the relevant exemptions from registration under the Securities Act and address potential Rule 10b-5 liability. A specific Rule 10b-5 style indemnity will also be required, as well as a separate “contribution” clause which is customarily included in international underwriting agreements because of uncertainties around the enforceability of indemnities in the United States.

In some jurisdictions there may (for a variety of reasons) be separate domestic and international underwriting agreements. An agreement among underwriters and/or an inter-syndicate agreement may also be used to regulate, among other things, the jurisdictions in which parties to each agreement may make offers and sales of the shares.

What additional forms of comfort will the underwriters expect to receive?

As mentioned previously, as part of establishing their due diligence defense the underwriters will require Rule 10b-5 disclosure letters from both their and the company’s US counsel. Such counsel will also be asked to provide “no registration” opinions confirming the availability of exemptions under the Securities Act. As part of their due diligence exercise, the underwriters are also more likely to ask for legal opinions from domestic counsel in relation to a number of specific issues as well as opinions from local counsel in jurisdictions in which the company has material subsidiaries.

Practices in relation to accountants’ comfort letters also differ in the United States compared to most non-US jurisdictions. As a consequence, it is customary for the accountants to be asked to provide a “US comfort” letter in addition to the domestic or “rest-of-the world” letter given in relation to the non-US offering. On US IPOs the accountants do not produce a formal long form (i.e. financial due diligence) report or written reports on areas such as working capital or financial position and prospects/financial reporting procedures, although the substance of these areas is covered as part of the due diligence exercise that is customarily done by the underwriters. Where, on an IPO with a Rule 144A tranche, such reports are required as a matter of domestic practice in the company’s market of listing, the accountants will therefore typically seek to exclude any liability for reliance on them in relation to sales of the shares in the United States.

Publicity and ongoing reporting obligations where the IPO has a Rule 144A component

Do additional restrictions on publicity and marketing apply in connection with the IPO?

Yes – additional publicity restrictions will be put in place intended to ensure that the shares are only sold within the United States to investors reasonably believed to be QIBs and that the non-US element of the offering complies with Regulation S, including there being no “directed selling efforts” in relation to the United States. Publicity guidelines will, in any event, be put in place at the outset for most international IPOs but these will need to be tailored to reflect the Rule 144A element of the deal.

In terms of early-stage marketing, it is also important to keep in mind that material information about the issuer that is to be used in “pilot fishing”, “early look” and “deep dive” investor presentations (and will likely ultimately make its way into the prospectus/offering circular) should, in addition to compliance with domestic requirements, be vetted for suitability for use in the United States and verified before it is shared with investors.

Research is customarily not distributed in the United States (whether or not there is a Rule 144A element to the offering) and research procedures will be put in place to reflect this as well as any other restrictions that may apply under domestic rules.

Will the company be subject to any public reporting requirements post-IPO?

A company will not become a public reporting company in the United States under the Exchange Act simply because it includes a Rule 144A tranche in its IPO. Although there is a requirement for the company to provide certain information to investors on request⁸ (and for such information to be reasonably current and accessible to ensure QIBs can make informed investment decisions), there is an exemption⁹ available to foreign private issuers that are listed on a non-US exchange and which make their home country disclosures publicly available in English (typically by including them on their corporate website).

Will any restrictions apply to future share offerings?

The US element of the company’s shareholder base will mean that greater care will need to be taken to ensure any rights issues or other pre-emptive offerings are managed in accordance with US securities laws requirements. This may, where an appropriate exemption from registration under the Securities Act is not available or because of liability concerns, result in US holders being excluded from the offering. Where a future share offering is extended into the United States, consideration will also need to be given to potential liability under Rule 10b-5 and the associated impact on the transaction documentation.

With thanks to Alex Green and Kathy MacDonald for their contributions.