Company Name: Cravath, Swaine & Moore
Sales of Convertible Securities Under Regulation S
Public Availability Date: Aug. 26, 1998 

[LETTER OF INQUIRY]

August 24, 1998

Sales of Convertible Securities
Of U.S. Reporting Companies
Under Regulation S

Ladies and Gentlemen:

We are writing to request that the staff of the Securities and Exchange Commission (the "Commission") confirm that it will not recommend enforcement action to the Commission if convertible securities of U.S. reporting companies are offered and resold under the conditions described below without implementation of the stop-transfer provisions or other procedures under Rule 903(b)(3)(iii)(B)(4) of Regulation S.

Introduction

Overview of Convertible Securities Market. The market for convertible securities of U.S. reporting companies is large and involves a broad cross-section of issuers. A significant portion of these securities is sold every year in private offerings under Rule 144A, most of which include a tranche of securities issued under Regulation S. For example, in 1997 an estimated $17 billion of convertible securities were sold by U.S. reporting companies in transactions under Rule 144A and Regulation S, constituting approximately 55% of all sales of convertible securities in that year by U.S. reporting companies. In the first quarter of 1998, approximately $6 billion of convertible securities were sold in such transactions, which constituted approximately 47% of all sales of convertible securities by U.S. reporting companies in that quarter.

The issuers in these transactions include large, widely followed companies such as Hewlett Packard, Banc One Corporation and Union Pacific Corporation as well as smaller companies. Virtually every major U.S. investment bank participates in the distribution of these securities. The purchasers of these securities are predominantly institutional, both in the United States and overseas. Unlike certain transactions identified by the Commission, these transactions do not involve the fraudulent or abusive practices cited by the Commission in Securities Act Release No. 7392 (February 20, 1997). The average conversion premium for these offerings was well above the 10% threshold required under Rule 144A.

Issuers that are U.S. public reporting companies may choose to sell convertible securities in private or offshore offerings for a variety of reasons. First, many issuers either do not have sufficient capacity under their shelf registrations or have chosen not to include convertible securities or common stock under those shelf registrations because of concern over the effect of the "overhang" of shelf-registered common stock on the trading price of that stock. Second, private offerings can be executed quickly, allowing issuers to take advantage of short-lived market "windows". Third, a significant number of these transactions has involved highly structured instruments issued by trusts or limited liability companies that are wholly owned by the issuer of the equity but are not themselves registrants under the issuers shelf registration statements.

Compliance with Amended Regulation S. Securities sold in the Euromarkets, including convertible securities, are customarily held in global form and traded through book-entry clearance facilities such as the Euroclear System ("Euroclear"), Cedel Bank or The Depository Trust Company ("DTC"). These systems currently do not have facilities that allow participants to obtain transaction-by-transaction representations or certifications of non-U.S. status from purchasers. The only way to obtain such certifications is to require securities to be held as definitive registered securities, which is costly, imposes additional settlement risks and, we believe, is not necessary in order to achieve the policy goals of Regulation S.

Rule 903(b)(3)(iii)(B)(4) ("Paragraph (B)(4)") under Regulation S requires an issuer, "by contract or a provision in its by-laws, articles, charter or comparable document, to refuse to register any transfer of securities not made in accordance with [the registration or exemptive provisions of the Securities Act]." The Commission noted in Securities Act Release No. 33-7505 (Feb. 17, 1998) (the "1998 Adopting Release"), that "these requirements will not be complied with easily in an offshore public offering" (1998 Adopting Release). Indeed, Paragraph (B)(4) itself recognizes that in the case of bearer securities (and certain other cases), alternative procedures reasonably designed to achieve the underlying purpose of Regulation S may be appropriate, as it provides that "if the securities are in bearer form or foreign law prevents the issuer of the securities from refusing to register securities transfers, other reasonable procedures (such as a legend described in paragraph (b)(3)(iii)(B)(3) of this section) may be implemented to prevent any transfer of the securities not made in accordance with the provisions of this Regulation S".

We believe that Paragraph (B)(4) was not intended to disrupt the practice of holding securities in global form through depositories such as the DTC, Euroclear or Cedel Bank, especially in the case of convertible securities meeting the requirements of Rule 144A, so long as reasonable procedures exist to ensure that such securities will not flow back into the U.S. market in violation of the Securities Act.

Issuers and investment banks are concerned that if U.S. reporting companies are required to issue convertible securities outside the United States in the form of physical definitive certificates, it would be a serious impediment to the ability of U.S. issuers and other distribution participants to effect offerings of convertible securities in reliance on Regulation S because non-U.S. investors strongly favor holding securities through book-entry systems and will not want to bear the costs, administrative burden and added settlement risk of being required to deliver physical securities and certifications of compliance upon each transfer. ¹

Proposed Procedures for Convertible Securities

In order to address the issues outlined above, we request that the staff confirm that it will not recommend enforcement action to the Commission for failure to comply with Paragraph (B)(4) if issuers and other distribution participants implement the following procedures with respect to convertible securities of U.S. reporting companies that meet the requirements of Rule 144A and maintain such procedures in effect for the duration of the distribution compliance period applicable under Rule 903 ²:

Securities Held in Global Form. Convertible securities issued pursuant to Regulation S may be held in global certificated registered or bearer form by a depository for a book-entry clearance facility such as DTC, Euroclear and Cedel Bank. ³ Offshore purchasers will hold interests in the global security through direct or indirect participants in such facilities, including other offshore book-entry clearance facilities.

Restricted Identifier. Both the securities sold under Regulation S and those sold under Rule 144A will be identified in the records maintained by entities such as the CUSIP Bureau ("CUSIP") as restricted under the Securities Act. CUSIP and other similar entities assign a number to each security that identifies the issuer and each outstanding security of that issuer. Each number has an associated security description, which includes an indication that such securities are subject to Rule 144A and/or Regulation S or otherwise that such securities are subject to restrictions under the Securities Act, so that participants in book entry clearance facilities and others that trade the securities will be aware that transfers of the securities to purchasers in the United States are restricted and must qualify under an available exemption. ⁴ In addition, any statement or communication confirming or summarizing the terms of any new issuance of such securities by the issuer or managing underwriters to publishers of publicly available databases will include a statement that such securities have not been registered under the Securities Act and are subject to Rule 144A and/or Regulation S. ⁵

Deemed Representations. The offering circular will set forth representations of non-U.S. or QIB status (or other applicable exceptions) and the agreements regarding restrictions on resale and hedging pursuant to Regulation S (and, where appropriate, Rule 144A) that purchasers from issuers, distributors or their affiliates are deemed to make.

Restrictive Legends; Certifications. Any certificated securities, including both global securities and any physical certificated securities issued to holders prior to the expiration of the distribution compliance period, will bear a restrictive legend. Thereafter such certificated securities will bear a restrictive legend to the extent required by Rule 144. In addition, any definitive securities issued during the distribution compliance period (other than in a transaction subject to Rule 144A) will satisfy all the requirements of (B)(4), including the legending and certification requirements.

If you have any questions or require additional information with respect to the matters discussed herein, please call the undersigned at (212) 474-1270 or Andrew J. Pitts at (212) 474-1620. Seven additional copies of this letter are enclosed.

Very truly yours,

William P. Rogers, Jr.
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Encls.

[STAFF REPLY LETTER]

August 26, 1998

RESPONSE OF THE OFFICE OF INTERNATIONAL CORPORATE FINANCE
DIVISION OF CORPORATION FINANCE

Re: Sales of Convertible Securities of U.S. Reporting Companies Under Regulation S

Incoming letter dated August 24, 1998

Based on the facts presented, the Division will not recommend enforcement action to the Commission if convertible securities of U.S. reporting companies that are eligible for resale under Rule 144A and that are held in global certificated form (as either registered or bearer securities) by a depository for a book-entry clearance facility are offered and resold pursuant to Regulation S without implementation of the stop-transfer provisions or other procedures set forth under Rule 903(b)(3)(iii)(B)(4) of Regulation S, provided that during the applicable distribution compliance period:

(1) the convertible securities are identified by its CUSIP or other issuer identification number as restricted, so that participants in book-entry clearance facilities and others that trade the securities will have notice that transfers of the securities to U.S. purchasers are restricted and must qualify under an available exemption (absent registration);

(2) any information provided by the issuer or managing underwriters to publishers of publicly available databases about the terms of any new issuance of convertible securities includes a statement that the securities have not been registered under the Securities Act of 1933 ("Securities Act") and are subject to restrictions under Rule 144A and/or Regulation S;

(3) the offering circular used in the Regulation S offering of the convertible securities contains representations deemed to be made by purchasers in the offering regarding their non-U.S. status (or other exempt status, such as qualified institutional buyer status under the Rule 144A exemption from registration), and contains agreements deemed to be made by purchasers under Regulation S (and, where appropriate, Rule 144A) regarding restrictions on resale and hedging; and

(4) any certificated securities, including both global securities and any physical, certificated securities issued to holders prior to the expiration of the distribution compliance period, bear an appropriate restrictive legend. Thereafter these certificated securities will bear a restrictive legend to the extent required by Rule 144. Any definitive securities that are issued during the distribution compliance period (other than in a transaction subject to Rule 144A) must satisfy all of the requirements of Rule 903(b)(3)(iii)(B)(4), including the legending and certification requirements.

Our view is limited to convertible securities offered or resold under Regulation S, and does not affect the applicability of Rule 903(b)(3)(iii)(B)(4) to any equity securities that are issued upon the conversion of the convertible securities during the distribution compliance period. Debt securities that are convertible into equity securities of a person other than the issuer would, in our view, also be considered convertible securities for purposes of Regulation S.

Because these positions are based on the representations set forth in your letter, it should be noted that any different facts or conditions might require a different conclusion. Furthermore, this response represents the Divisions position as to enforcement action, and does not express any legal conclusions with respect to the specific questions presented.

Sincerely,

Felicia H. Kung

Special Counsel

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