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The Securities and Exchange Commission is limited by restrictions that do not necessarily apply to a private company or individual. The basic restriction on the SEC's regulatory authority is geographical; its authority does not extend beyond the borders of the United States. It is therefore possible to construct a series of domestic and foreign transactions that might not be legal in a single country but that are legal in the country in which each transaction takes place. Such a series of transactions requires careful planning and expert legal and financial advice, but can be a fast and private way to raise money.
Here is an example of how such a financing plan might work. Quantum, Inc. is a small but innovative electronic company that needs money in a hurry for substantial speculative research. An eventual breakthrough in the research project would reap tremendous rewards but no breakthrough can be guaranteed. For these reasons, Quantum would have liked to finance this research by going public. However, because of difficulties and delays imposed upon companies going public in the United States, a normal regulated public offering cannot meet Quantum's needs. Time is of the essence in the highly competitive field of electronics.
Step 1: Incorporate Honk Kong holding company. The series of transactions necessary to generate capital for Quantum begins with the incorporation of a Honk Kong company named Quantum Holding, Limited. Honk Kong has been chosen for this example but any of 15 other jurisdictions could have been used. Quantum Holding is incorporated and managed by nominees, and its scope of authority is severely limited. The number of its authorized shares and their par value identical to those of Quantum.
Step 2: Holding company purchases stock from Quantum. Quantum Holding makes an offer to Quantum to purchase 10,000 shares of Quantum stock, the same number Quantum would have issued if made a public offering. In lieu of cash, Quantum Holding pay for the shares with a one-year promissory note. This transaction is permitted under securities regulations because the buyer is foreign and no offer to sell is made domestically.
Step 3: BDR are sold in London. The nest step is for Quantum Holding to issue 10,000 shares of its stock, placing them with a St.Vincent bank that act as depository. In exchange, the depository bank issues 10,000 bearer depository receipts (BDRs). These BDRs are placed, on best-efforts basis, (in some cases this function is not needed or can be performed elsewhere). Arrangements are also made for the broker-dealer to act as market maker for the BDRs as well. Note that these transactions do not take place domestically and do not involve domestic nationals. Therefore, they are beyond the jurisdiction of domestic securities regulations. In the countries in which the transactions occur, they comply fully wit local laws and regulations.
Step 4: BDR proceeds are paid to Quantum. When the BDRs have been sold, the funds generated from the sale are remitted to the depository bank in the West Indies. Under prior agreement, the depository bank forwards them directly to Quantum, on behalf of Quantum Holding, to retire the promissory note. As before, this series of payments is fully permissible in the jurisdictions through which they pass.
The only legal caveat that should be made at this point is that securities regulations do not permit such a sale if there is a pre-existing intent to distribute the bearer depository receipts domestically or to distribute them to domestic nationals abroad, except by unsolicited private placements. Although one cannot be held accountable for who ultimately possesses these bearer documents, it would be improper for the distribution to be made with the express intent of putting such BDRs in the hands of fellow citizens on a general offering basis.
Another example of how bearer depository receipts work is provided by Maple Leaf Real Estate, Inc. It is a publicly held company. However, large blocks of its stock are held by management and promoters in lettered or restricted form. These shareholders are active in a wide range of capital intensive business dealings, many of which require a high degree of liquidity from their participants. For this reason, the management of Maple Leaf Real Estate would like to accommodate its needs for liquidity through the legal transfer of the lettered shares.
Step 1: Shares are deposited and BDRs issued. To provide the needed liquidity, an agreement is entered into with an offshore bank to act as a depository for shares of Maple Leaf stock. Under this agreement, the depository bank issues bearer depository receipts in exchange for shares of Maple Leaf stock deposited by both Maple Leaf and other holders. These BDRs can be held by the owners of the deposited stock or by the depository bank itself under a placement agreement.
Step 2: BDRs are sold through London market maker. As in the case of Quantum, arrangements are made to have a London broker-dealer act as a market maker for the BDRs. Once this is done, the market maker may be contacted directly for the buying or selling of BDRs. If preferable, the depository bank places the BDRs with the market maker for sale on behalf or the depositor of the original shares of Maple Leaf stock.
Step 3: BDR sale proceeds are paid to stock owners. The funds from such sales are remitted to the depositors of the shares, thus providing them with the liquidity they seek. In addition to the greater flexibility that holders of restricted shares of Maple Leaf Real Estate now have, Maple Leaf itself raises capital from new offerings, just as Quantum did.
Note that in each case there is no restriction on domestic buyers purchasing the BDRs on their own initiative. However, no recommendation may be made to a local client to buy the BDRs through the London market maker. On the other hand, a duty to disclose the existence of a London market for the related BDRs arises when such information is material to a domestic transaction.
Gilt Complex Mining is a newly claimed, one-man gold mining operation in Colorado. Although assay reports have been very good, (0.47 to 0.63 ounces per ton), the extent of the ore body has not yet been fully determined. Another uncertainty arises from the fact that the ore is made up of complex gold-telluride compounds that may be very expensive to refine.
In spite of these problems, the owner of Gilt Complex believes that the company's claim can be brought into profitable production if enough money is raised. A number of social and business associates have expressed an interest in investing but the funds they could contribute fall short of what is needed to bring the mines into operation.
Because of the highly variable gold market, the delay inherent in a full-blown SEC registration is considered unacceptable. As the company is in the initial stages of development of its mining properties, its funds are already committed to assessment of the claims, payments on equipment, and salaries. There are no extra moneys available to pay for an offering of BDRs through London as described in previous examples. An analysis of Gilt Complex Mining's situation suggests that a two-stage procedure should be used to raise funds.
Step 1: Raise seed money. The first step is to raise as much money as possible through domestic private placements. The owner's friends and acquaintances, (numbering no more than the SEC-approved limit of 35), and unlimited numbers of sophisticated investors, (those investing more than US $ 150,000 in cash), can be approached and persuaded to invest.
Step 2: Seed money funds BDR London offering. This private-placement seed money is then used to fund a Honk Kong holding company and BDR sales in London as in the example of Quantum, Inc.
These two steps complement one another. The first phase provides money for the second and the second phase gives the domestic private-placement investors an easily ascertainable fair market value for their shares. All that they need do, if they wish to determine what their shares are worth, is to find out what the BDRs are trading for in London.
This document was excerpted, modified & otherwise prepared by the 'Lectric Law Library ('LLL) from materials supplied by Baltic Banking Group - www.BalticBankingGroup.com Copyright 1998 - 2002 'LLL & BBG, all rights reserved.