Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation
Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation
Joel P. Trachtman 0 1
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1 Joel P. Trachtman, Recent Initiatives in International Financial Regulation and Goals of Competitiveness , Effectiveness, Consistency and Cooperation, 12 Nw. J. Int'l L. & Bus. 241, 1991-1992
Recent Initiatives in International
Financial Regulation and Goals of
Consistency and Cooperation
Joel P. Trachtman *
This article will examine limited features of the U.S. international
regulatory regimes associated with banking and securities in order to
compare recent approaches of these regimes to financial activity by
foreigners in the U.S. and at home, and by U.S. persons or their subsidiaries
abroad. The features examined have been selected based on their
centrality to the bank and securities regulation regimes, their particular
international concerns and the circumstance of recent administrative and
legislative emphasis. Similar methods of analysis could be applied to
The purpose of this examination is first, to review the basis for and
method of applying U.S. regulation in these functional areas to offshore
activities of U.S. persons and to both U.S. and offshore activities of
foreign persons, and to understand the differences in approach taken by the
* Assistant Professor of International Law, The Fletcher School of Law and Diplomacy. The
author expresses his gratitude to Cynthia Lichtenstein, Glen Tobin and Phillip Wellons for their
advice and comments on a prior draft of this article, and to Melinda Harris and Elisabeth Shapiro
for their assistance in researching this article.
Board of Governors of the Federal Reserve System (the Board) and the
Securities and Exchange Commission (the Commission) in interpreting
the reach of prescriptive jurisdiction under the Bank Holding Company
Act of 1956 (the BHC Act),1 the Securities Act of 1933 (the Securities
Act)2 and the Securities Exchange Act of 1934 (the Exchange Act).3 The
second purpose of this examination is to understand how these
approaches compare and relate to certain international or regional
initiatives, particularly those of the Basle Committee on Banking Supervision
(the Basle Committee) and the European Economic Community (the
This article will examine initiatives relating to three basic and
related types of financial regulation: first, regulation of financial institution
powers and prudence; second, regulation of financial institution capital;
and third, regulation of financial transactions. The principal U.S.
regulations that this article will discuss are:
1. Regulation K4 (including recent revisions thereof) under the BHC Act
and sections 255 and 25(a)6 of the Federal Reserve Act, concerned with the
types and extent of activities not normally permitted to U.S. banking
organizations that subsidiaries of U.S. banking organizations and that foreign
banking organizations operating in the U.S. may undertake abroad;
2. Rule 15a-6 7 under the Exchange Act, concerned with the
circumstances under which a foreign securities broker-dealer engaging in activities
in the U.S. will not be required to register as a U.S. broker-dealer under
Section 15(a)8 of the Exchange Act; and
3. Regulation S9 under the Securities Act (as well as the related TEFRA
D Rules' ° under the Internal Revenue Code), concerned with the
circumstances under which a public offering of securities effected outside the U.S.
is not required to be registered under Section 511 of the Securities Act.
These regimes established by the Board and the Commission go to'
the question of the extent of U.S. regulation of offshore financial
activities. This article will compare these approaches with related bilateral
U.S. initiatives, with regional initiatives of the European Community and
with the Basle Committee's multilateral initiative in the area of capital
The question posed by this article is, why are there differences in the
reach and grasp of these aspects of bank and securities regulation?
Further, are these differences sensible, based on the varying purposes of these
laws? Are these differences justified by the legislation that underlies the
regulation-in other words, has the U.S. made these decisions at its
highest policy levels, and should it? Are these differences defensible from the
standpoint of efficiency in international finance, and is the inconsistency
that in fact exists acceptable to other countries? If not, what alternative
approaches are available?
Different countries have different approaches to finance. Despite the
revolution in Eastern Europe, many countries still allocate finance using
some degree of central planning. Many countries still use financial
regulation or guidance domestically to implement industrial or social policy
by directing finance toward selected uses in ways that the private market
would not. Even countries that emphasize the market as allocator of
finance have varying approaches to financial regulation, based on varying
regulatory experience, legal culture, economic history and regulatory
International financial regulation is one of the primary areas of
attention in connection with proposals to liberalize trade in services. Trade
in financial services is being addressed in the Uruguay Round under the
General Agreement on Tariffs and Trade (GATT).12 International
finance, however, is not merely a service, but is also a critical factor of
production. Few doubt that aggregate worldwide welfare would be
enhanced by permitting finance to flow freely to the uses selected by an
international free market process. All recognize that uncoordinated
national regulatory systems are barriers to this flow.
In considering reform of regulation, it is necessary to consider the
costs and benefits of present structures, as well as the costs and benefits of
12 See, eg., Uruguay Round Service NegotiatorsMove to Small Groups in Hope of September
Texts, 57 BANKING REP. (BNA) 198 (July 2
), indicating that talks on financial services trade
is "quite far advanced," based on two similar proposals to enhance requirements for national
Northwestern Journal of
International Law & Business
proposed reforms. This process is complicated enough in the domestic
context, requiring careful scientific review of the social costs of, and
social benefits from, regulation. However, in order to enhance worldwide
aggregate welfare, 3 it is necessary to consider regulation on the basis of
worldwide costs and worldwide benefits. This article seeks to begin to
consider how financial regulation initiatives may be evaluated in this
The analytical factors that might be evaluated with respect to
substantive domestic regulation include the social benefits expected to be
derived from the regulation and the social costs expected to be incurred
in order to implement the regulation. This calculus requires an added
dimension in order to evaluate international regulation. This added
dimension includes the related problems of (a) regulatory effectiveness in
the context of transnational finance, (b) competitiveness of domestic
financial and non-financial enterprise in the global economy, (c)
consistency of approach with respect to the outside world, and (d) bases for
and methods of cooperation in international financial regulation. These
issues have an effect on the determination of regulatory structure and
There are two categories of regulatory concerns that merit special
consideration in the international context. First, international regulation
is concerned with regulatory effectiveness: to what extent does the
discontinuity between transnational finance and national regulation
diminish the effectiveness of regulation in accomplishing its purposes, and how
can effectiveness be maintained? Regulatory effectiveness will be
challenged by transnational finance in different ways, depending on the type
of regulation involved. The discontinuity between transnational finance
and national regulation challenges regulators because it requires them to
apply regulation to persons or transactions that are not exclusively
located in their jurisdiction. This problem is often referred to as
extraterritoriality: under what circumstances should national regulation govern
such persons or transactions? Extraterritoriality is ameliorated by either
agreeing on what the substantive domestic rules should be, so that it
matters little which country's rules are applied, or agreeing on a method for
determining which country's substantive rules govern particular persons
13 It is not clear that this is any country's goal; in fact, the existence of protectionism belies this
as a possible goal. However, the success and demonstration effects of the European Community's
ability to subordinate short-term national welfare to long-term aggregate welfare makes this more of
a practical reality.
or transactions. Varying approaches may be appropriate for varying
types of regulation. 14
The general U.S. approach to extraterritoriality of regulatory
autarchy and autarky has lost some of its force in recent years 5 as a result of a
recognition that regulatory effectiveness is compromised by failure to
cooperate with foreign regulators, especially in the enforcement area.
The increasing organization of enterprise in corporations, and
particularly multinational corporate groups, allows greater flexibility to
business to engage in regulatory arbitrage, seeking to oust the jurisdiction
of national regulators that impose relatively high costs, in order to enjoy
the reduced cost of more efficient or more lax regulation in other
jurisdictions. While this process may have positive long-term effects as a
discipline on national regulation, as set forth below, in the short term, it may
diminish the effectiveness of regulation, including but not limited to
enforcement. Effectiveness can be restored through enhanced cooperation.
This observation generates certain consequences under the principle
of subsidiarity. This principle would call for a comparison of different
social needs and regulatory techniques in the particular regulatory
context, based on differences of economic development, legal and political
culture and economic institutions, among others, in order to identify the
most efficient levels at which to provide regulation. In the context of
finance of large enterprise, the most efficient level of regulation may be
global, insofar as a universal culture of large-scale enterprise has had a
homogenizing effect on regulatory goals of economic efficiency, as well as
on possible regulatory techniques. There is already a level of business
integration in this area that involves global financial activity and
arbitrage, as well as global regulatory arbitrage in finance. Thus, in order for
at least some aspects of large-scale financial regulation to be effective, it
must be coordinated, and perhaps also formulated, on a global basis.
14 Professor Scott and Ms. Key have recently suggested a matrix for analysis of different types of
bank regulation, with a view to clarifying the rules that should govern international trade in banking
services. They relate the decision among home country regulation, host country regulation and
harmonization to the means by which services are provided and to the regulatory or other policy
goals sought to be achieved. S. KEY & H. SCOTT, INTERNATIONAL TRADE IN BANKING SERVICES:
A CONCEPTUAL FRAMEWORK (1991).
15 It probably reached its zenith in 1984 in connection with the Commission's proposed and
ultimately abandoned doctrine of "waiver by conduct." Under this doctrine, persons trading in U.S.
markets would be deemed to implicitly waive foreign bank secrecy and other protections afforded by
foreign law. Exchange Act Release No. 21,186, 31 SEC Docket (CCH) 14 (July 30, 1984). See
Fedders, PolicingInternationalized U.S. CapitalMarkets: Methods to Obtain Evidence Abroad, 18
INT'L LAW. 89 (1984).
Second, international regulation is concerned with competitiveness;
this concern is increasingly explicit. Competitiveness must be considered
from several perspectives. One perspective considers the regulatory costs
incurred by domestic business in comparison to those incurred by foreign
competitors: is the domestic regulatory system a negative "factor
endowment"? Another perspective considers the ability of domestic business to
compete in foreign markets: do domestic persons incur additional costs
in foreign host countries in order to comply with home country
regulation? Still a third perspective considers the ability of foreign competitors
to compete in local markets: are foreign competitors, who may benefit
from low home country regulatory costs, or even regulatory subsidies, or
who may otherwise be strong competitors, permitted to compete in
domestic markets? These issues are addressed explicitly in the formulation
of tax policy, where the burden on competitiveness is more apparent and
The policy direction indicated by the competitiveness concern is
often unrelated to or opposite to that indicated by the regulatory
effectiveness concern. Thus, in formulating policy, these concerns may be
required to be compromised between themselves, as well as with other
concerns. They will be least inconsistent if two conditions are fulfilled:
first, if the competitiveness concern is limited to the first perspective
mentioned above-limiting regulatory costs incurred by business-and
second, if the regulation concerned is market-facilitating rather than
market-inhibiting. That is, the competitive drive to limit regulatory costs
will be more consistent with the goal of regulatory effectiveness if
regulatory effectiveness is defined in terms of ability to enhance economic
efficiency. This is so because if regulatory effectiveness is defined this way,
costs would not be permitted to exceed efficiency benefits. In addition,
16 See, e.g., Plambeck, CapitalNeutralityand CoordinatedSupervision: Lessonsfor International
Securities Regulationfrom the Law of InternationalTaxation and Banking, 9 MICH. Y.B. INT'L
LEGAL STUD. 19
). International tax analysis considers three aspects of neutrality in
connection with its attempt to provide economically neutral taxation. First, capital export neutrality calls
for equal taxation on domestic and foreign investment by domestic persons. Second, capital import
neutrality from the standpoint of a foreign host country calls for an equal tax burden on both foreign
and local investors in connection with local investments. Third, national neutrality calls for equal
tax receipts to the home country regardless of where its nationals' investments are made. These
principles are mutually inconsistent, insofar as they assume the propriety of tax jurisdiction on the
basis of both residence and source. For an economic analysis of the effects of competition, and of
coordination, among tax jurisdictions, see P. Musgrave & R. Musgrave, Fiscal Coordinationand
Competition in an InternationalSetting, in INFLUENCE OF TAX DIFFERENTIALS ON
INTERNATIONAL COMPETITIVENESS: PROCEEDINGS OF THE VIIITH MUNICH SYMPOSIUM ON
INTERNATIONAL TAXATION (McLure, Sinn, Musgrave, et al. eds. 1990).
positing economic efficiency as a harmonized goal would lead to
convergence of regulation, diminishing competitive inequalities.
Market-facilitating regulation is regulation that facilitates the
operation of the financial market to allocate capital efficiently. Disclosure
regulation in connection with public offerings of securities is an example.17
An example of market-inhibiting regulation might be regulation that
prevents banks from branching across state borders in the United States
when it would otherwise be economically efficient for them to do so.
This categorization is not intended to indicate that market-inhibiting
regulation is necessarily to be avoided: such regulation may serve an
important social policy for which a society is willing to pay in terms of reduced
allocative efficiency. Rather, it is merely intended to indicate that where
regulatory costs are imposed merely to maintain the efficiency of the
market, and not to achieve other social goals, the costs will be minimized
in a way that promotes competitiveness.
The globalization of finance is a nemesis of inefficient financial
regulation. International trade disciplines domestic industry by subjecting it
to competition from abroad. On a higher plane, international trade
disciplines domestic regulatory regimes. Inefficient regulation imposes costs
on domestic industry that are not commensurate with the social benefits
obtained. Even efficient, market-facilitating regulation can hinder the
competitiveness of domestic industry where lax foreign regulation
imposes lower costs on foreign competitors. As more efficient financial
regulation is developed in one national jurisdiction that can meet the needs
of economic efficiency and stability more effectively or at a lower social
cost than other methods, the retention of the other methods imposes an
unjustified cost on providers and users of finance. These costs render less
competitive the financial institutions, and the industrial firms that must
buy financing from these financial institutions, in the jurisdiction with
the less efficient regulation.
On February 5, 1991, pursuant to section 1001 of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989
(FIRREA), 8 Secretary of the Treasury Nicholas Brady provided to Congress
17 There is a counter-argument to the effect that the market can impose its own disclosure
disciplines. For a cogent analysis of these arguments, see Coffee, Market Failureand the Economic Case
for a Mandatory DisclosureSystem, 70 VA. L. REv. 717 (1984). For a discussion of the possible
differences between bank regulation and securities regulation in this regard, see Trachtman,
Perestroika in Bank Regulation: Advantages of SecuritiesRegulationfor a Market Economy, in BANK
REGULATION AND SUPERVISION IN THE 1990's (J. Norton ed. 1991).
18 § 1001 of the FIRREA, 12 U.S.C. § 1811 (1989) [hereinafter FIRREA]. See, e.g., Gail,
Highlights ofthe FinancialInstitutionsReform, Recovery and EnforcementAct of 1989 (FIRREA): What
ForeignBanks Should Know, 24 INT'L LAW. 225 (1990).
a report entitled "Modernizing the Financial System: Recommendations
for Safer, More Competitive Banks."1 9 On March
, a bill was
introduced in Congress to implement the recommendations made in this
report.20 In this report and proposed legislation, the U.S. Treasury
proposed a wide-ranging reform of the U.S. system of bank regulation, with
principal goals to break down functional borders between banking and
the securities and insurance businesses, and between banking and
commerce, as well as to break down barriers to interstate banking. This
initiative is motivated by the challenge of global economic competition. The
Treasury stated that "[a] sound, internationally competitive banking
system is critical to the Nation's economic vitality and the financial
wellbeing of our citizens. 2 1
The U.S. bank regulation and securities regulation regimes have
come under increasing competitive pressure to reduce regulatory costs
(including opportunity costs due to foregone business) to the minimum
necessary, in order to allow U.S. regulatory clients to compete on the
most favorable basis possible, consistent with regulatory goals. Adding
to this pressure are inconsistencies caused by the introduction of first,
less onerous foreign regulation of U.S. regulatory subjects operating
abroad and second, foreign financial organizations operating in the U.S.
that do not meet the requirements of U.S. regulatory law, but that cannot
reasonably be excluded. They cannot reasonably be excluded from the
U.S. market for two reasons: first, because the system of regulation
under which they operate has proven adequate to address the
fundamental regulatory concerns that underlie U.S. regulation, and second,
because their exclusion would prompt retaliation under the justification of
Thus, from the standpoint of formulating international regulation,
the approach taken to competitiveness matters, as does the approach
taken to regulatory effectiveness. Both these factors will have an effect
on a particular country's willingness to cooperate with other countries,
either explicitly or implicitly.
Implicit cooperation may take the form of unilateral action that
defers to other countries by limiting the scope of regulatory jurisdiction or
providing de jure and de facto national treatment to foreign nationals,
with expectations and hopes, or even unilateral requirements, of
reciprocation by the foreign government. The reciprocation may amount to a
tacit, consciously parallel agreement with foreign countries. Another
form of implicit cooperation unilaterally provides benefits to foreign
countries that provide reciprocal benefits: unilateral reciprocity.
Explicit cooperation involves bilateral, regional or multilateral
agreements, establishing institutional structures to constrain future
action. The first level of explicit cooperation would involve reciprocal
agreements to provide national treatment. This would involve no
reduction of national regulatory effectiveness, and would compromise only one
type of competitiveness: the ability explicitly to exclude foreign
competitors. National treatment is a complex concept with significant
difficulties, but can be treated here as impartial application of host country rules
to foreign entities.2 2 A reciprocal national treatment standard, assuming
it could be judged and enforced impartially, would reduce intentional
barriers to trade in financial services. It would have little effect on de
facto or unintentional barriers arising from differences in national
regulation. It would also have little effect on regulatory differences that are not
significant as barriers, but that merely reduce efficiency and raise the
costs of transnational flow of finance.
A second level of explicit cooperation would involve agreement on
reduction of unintentional barriers. This might involve agreement on
compromise of regulatory effectiveness in order to provide de facto
national treatment, or even better-than-national treatment, to foreign
A third level of explicit cooperation would seek to reduce regulatory
differences that do not amount to significant defacto barriers, but that by
virtue of their mere difference, raise the costs of transnational flow of
finance. This type of cooperation would compromise regulatory
effectiveness to the extent that it requires general changes in national
regulation that would reduce the ability to effectively address regulatory goals
that had previously been addressed. It would compromise competitive
concerns to the extent that such concerns are protectionist rather than
liberal. It would require joint legislation, which would necessitate a high
level of congruence of policy and approach, and which would benefit
from an institutional and constitutional infrastructure that would
facili22 For a detailed discussion of the concept ofnational treatment, see Key, Is NationalTreatment
Still Viable? US Policy in Theory and Practice,5 J.INT'L BANKING L. 365 (1990).
tate agreement, as well as neutral enforcement without the possibility of
retaliation for defection or alleged defection.
Consistency and Mode of International Discourse
In order to consider how the concerns for regulatory effectiveness
and competitiveness are evaluated and compromised in international
cooperation, it is necessary to consider the actors involved and the context
and fora in which they work.
In the U.S. context, much authority has been delegated to or
assumed by functional administrative agencies to determine how to apply
U.S. regulation to persons or transactions that do not relate exclusively
to the United States. This authority has been exercised in establishing
unilateral frameworks of reciprocity or deference, as well as, in the case
of capital requirements for banks, in establishing agreed substantive
rules. Because of the failure to address these issues at the highest
legislative policy level, there is a good deal of incoherence of policy among
functional agencies, within functional agencies and between the
functional agencies and another group of decision-makers: the courts. This
atomization of international regulatory policy authority has adverse
consequences for the ability to cooperate effectively.
In each of the areas of regulation discussed in this article,
prescriptive jurisdiction is exercised over foreign persons or transactions for
different reasons and under different circumstances. Thus there is
inconsistency in the extraterritorial scope of varying types of U.S.
financial regulation. There is also inconsistency within types of regulation.
These inconsistencies arise from variation in the basis for application of
U.S. law: nationality, territorial effects and territorial conduct.
For example, in banking regulation, nationality is used as a basis to
regulate the activities of U.S. banks abroad, while territoriality is used to
regulate the activities of foreign banks in the United States. The
nationality basis is congruent with the principal thrust of U.S. banking
regulation, which regulates institutions in order to ensure their safety and
soundness, but it is extended by the territorial conduct principle where
foreign banks do business in the United States, in order to avoid possible
gaps in regulation, as well as competitive discrimination against U.S.
firms. Similarly, a relatively small amount of U.S. conduct could result
in a foreign broker-dealer being subjected to the full panoply of U.S.
broker-dealer regulation with respect to its foreign operations, in order to
protect U.S. customers from foreign broker-dealers that are not subject
to U.S. regulation.
Of course, inconsistency is not necessarily inappropriate. However,
it is not necessarily appropriate. When each regulator forms its approach
to these problems, it often pays little heed to the approach taken by the
other regulators, to the approach used by foreign regulators, or to the
need to cooperate with foreign regulators. It should consider these
issues, because the United States is a polity of limited powers, the limits in
scope of which are not specifically defined.2 3 This lack of definition in
the Constitution, in U.S. statutes and in international law should not be
regarded as an invitation to excess, but rather as a source of
responsibility, where unilateral action is necessary, to act on a coherent basis, with
due regard for the aggregate of U.S. assertions of prescriptive power and
the limits of that power, as well as for the actions by foreign counterparts
in similar circumstances.
U.S. regulators should consider the approach taken by other U.S.
regulators in order to present to the outside world a coherent vision of
the scope of U.S. powers, unfragmented by varying levels of regulatory
zeal lacking the moderation that would be instilled by a larger
perspective. They should consider the approach taken by foreign regulators
because the problem of overlapping and inconsistent regulation among
countries can only be resolved by explicit or implicit agreement with
other regulators regarding the scope of permissible application of law:
agreement on conflict of laws rules. In the European Community's
single market initiative, this agreement on which country's law governs is
predicated upon a minimal agreement on the content of law. Thus,
consistency of internal approach requires a high degree of formal and
informal cooperation among regulators within the United States, while
consistency of approach among countries is a prerequisite for competitive
fairness and to avoid the application of regulation being used to promote
domestic industry in an escalating regulatory trade war that would be
costly to all.
Problems of Authorization
Congress has often declined to squarely address the issue of
regulatory scope.2 4 For example, in connection with antitrust laws, 25 securities
23 Neither the Constitution nor international law provides firm guidance as to the scope of a
state's power, although it might be argued that these sources should, if they do nothing else, define
the scope of the prescriptive power of our country.
24 See RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 6(2), comment c (1971). See also
Brilmayer, The ExtraterritoriaAlpplication of American Law: A Methodologicaland Constitutional
Appraisal,50 LAw & CONTEMP. PROBS. 11, 15 (Summer 1987). The Supreme Court, in Boureslan
v. Arabian American Oil Company, 111 S. Ct. 1227 (1991), has recently held that certain statutory
U.S. civil rights
(under Title VII of the 1964 Civil Rights Act)
are inapplicable to the activities of
U.S. businesses operating abroad, as Congress did not evince sufficient intent that they be so
applicalaws, 26 export control laws,27 certain aspects of the tax laws, 28 and
certain aspects of intellectual property laws, 29 U.S. statutes are unclear as to
the scope of jurisdiction intended to be exercised, at least in the sense
that they claim prescriptive jurisdiction over matters that exceed the
grasp of the United States. Congress appears to assume that it is not
limited by international law in its assertion of jurisdiction.
At the time that many of these laws were first enacted, the main
concern of Congress regarding foreign activity was evasion of U.S. rules
by people who deserved to have these rules applied to them, so the scope
of application was drafted expansively in order to avoid providing a
roadmap for evasion. However, there are other reasons, most of which
are beyond the scope of this article.
First, the U.S. has not moderated the scope of its jurisdiction
because it has not been required to do so. One reason why the U.S. has not
been required to moderate the scope of its jurisdiction is its heretofore
preeminent economic and political power in the world, making other
countries unwilling to confront the U.S. over these issues. As has been
discussed in other contexts, the balance of power is continually shifting,
and this reason for failure to moderate is less applicable today.
Second, the U.S. has not moderated the scope of its jurisdiction
because in the past it has been easier to see extraterritorial assertions of
jurisdiction as something less than a policy conflict: the U.S. was
prohibiting activities that foreign governments did not condone or encourage,
but had not gotten around to prohibiting. The U.S. was filling a
regulatory gap, acting as business police to the world. This is no longer
acceptble. This has been viewed by some commentators as a challenge to Congress to clarify the
extraterritorial reach of these provisions.
25 The literature regarding extraterritoriality in antitrust is voluminous. A relatively recent and
thoughtful opinion, citing much of the literature, is Laker Airways v. Sabena, Belgian World
Airlines, 731 F.2d 909 (D.C. Cir. 1984). Judge Wilkey criticized the reasonableness test, described in
RESTATEMENT (THIRD) OF THE FOREIGN RELATIONS LAw OF THE UNITED STATES §§ 403 and
415 (1987). In addition, the Department ofJustice has promulgated Antitrust Enforcement
Guidelines for International Operations, giving an executive perspective on proper means to determine the
scope of prescriptive jurisdiction under the antitrust laws. U.S. Dep't of Justice,
AntitrustEnforcement Guidelinesfor InternationalOperations, reprinted in 55 ANTITRUST & TRADE REG. REP.
(BNA) 1391 (Nov. 17, 1988). See also Foreign Trade Antitrust Improvements Act of 1982, 15
26 See, e.g., Sachs, The InternationalReachof Rule l0b-5: The Myth of CongressionalSilence, 28
COLUM. J. TRANSNAT'L L. 67
27 See, eg., Abbott, Defining the ExtraterritoriaRleach of American Export Controls: Congress
as Catalyst, 17 CORNELL INT'L L.J. 79 (1984).
28 See discussion of the TEFRA-D rules at text accompanying notes 174-178, infra.
29 See, e.g., American Rice, Inc. v. The Arkansas Rice Growers Cooperative Assn., 701 F.2d 408
(5th Cir. 1983) (extraterritorial reach of U.S. trademark law); Wells Fargo & Co. v. Wells Fargo
Express Co., 556 F.2d 406 (9th Cir. 1977) (same).
able for two reasons. The absence of a prohibition in foreign law is
increasingly viewed as an affirmative policy decision to permit certain
activity, especially in free market economies. And the U.S. is not viewed
as having state-of-the-art, neutral business regulation. Others have
evaluated U.S. regulation and devised other structures that they find more
The above serve as explanations for congressional silence on the
issue of extraterritorial scope. The regulators have largely filled the gap
left by Congress, and have done so from the perspective of fulfilling their
specific regulatory function in accordance with their legislative and
political mandates. However, this perspective is incomplete.
FINANCIAL INSTITUTION POWERS AND PRUDENTIAL
REGULATION: REGULATION K AND THE SECOND
This section will consider certain critical features of U.S. bank
regulation relating to institutional powers that have raised concerns regarding
competitiveness and interaction with foreign standards. It will then
describe how Regulation K ameliorates these concerns, both for U.S.
banking organizations and for foreign banking organizations operating within
the United States, and how the recently adopted revisions to Regulation
K were intended to further ameliorate these concerns. It will next
consider how the approach of Regulation K differs from, and interacts with,
the European Community's Second Banking Directive.30 Finally, it will
examine institutional regulation of securities firms under the European
Community's proposed Investment Services Directive3 1 (which is
modelled on the Second Banking Directive) and the Commission's recently
promulgated Rule 15a-6.
30 Second Council DirectiveofDecember 15, 1989 on the CoordinationofLaws, Regulations and
AdministrativeProvisionsRelatingto the Taking Up and Pursuitofthe Business of CreditInstitutions
and Amending Directive 77/780/EEC,32 O.J. EUR. COMM. (No. L 386) 1 (1989) (Council Directive
89/646/EEC) [hereinafter Second Banking Directive]. There are two companion directives to the
Second Banking Directive: Council Directive of 18 December 1989 on a Solvency Ratio for Credit
Institutions,32 O.J. EUR. COMM. (No. L 386) 14 (1989) (Council Directive 89/647/EEC)
[hereinafter Solvency Ratio Directive];CouncilDirective of 17 April 1989 on the Own Fundsof
CreditInstitutions, 32 O.J. EUR. COMM. (No. L 124) 16 (1989) (Council Directive 89/299/EEC) [hereinafter Own
FundsDirective]. For a discussion of the purposes and mechanics of the Second Banking Directive,
see, eg., Gruson & Feuring, The New Banking Law of the European Community, 25 ITrr'L LAW. 1
(1991); Zavvos, Banking Integration and 1992: Legal Issues and Policy Implications, 31 HARV.
INr'L L.J. 463 (1990).
31 Amended Proposalfor a CouncilDirective on Investment Services in the SecuritiesField,33 0.
J. EUR. COMM. (No. C 42)
) (Commission Notice No. 90/c 42/06) [hereinafter Investment
Services Directive]. This directive has been subject to significant negotiation, and subsequent
informal drafts have appeared.
Certain Salient Features of U.S. Domestic Bank Regulation
U.S. domestic bank regulation has two main features that raise
difficult issues for the world of international finance. These features were
inspired by some of the abuses that are blamed for the Great Depression
of 1929, and as in the securities area, the broad themes of U.S. bank
regulation were established in the New Deal legislation of the early
1930s. Many now question their propriety when adopted, or their
continuing validity, and they have been proposed to be modified significantly
in the Treasury's recently proposed legislation.32
First, commercial banking-the business of taking deposits and
making loans-is separated, to a diminishing but still significant extent,
from both the securities business3 3 and from most other areas of general
commerce. Banking organizations cannot generally engage in securities
underwriting or dealing, and securities organizations cannot generally
engage in deposit-taking. Banking organizations also cannot generally
own or be owned by commercial or industrial firms. 34 These regulatory
themes of separation are increasingly questioned 35 as possibly
over-re32 See Treasury Bill, supra note 20. The Treasury Report, supra note 19, recommends a number
of important reforms, which would be implemented by the Treasury Bill. These include (a)
nationwide banking, (b) permission for banking organizations to engage in new financial activities, (c)
permission for commercial ownership ofbanking organizations, and (d) reform of deposit insurance
that would involve a reduced scope for deposit insurance and capital-linked risk-based premiums for
deposit insurance. These reforms all have important ramifications for international banking. An
effort has been made to apply these reforms to the operations of foreign banking entities on a
national treatment basis, but of course, given differences in home country regulation and banking
structure, national treatment can amount to de facto discrimination. In addition, these reforms will affect
the competitive position of U.S. banking organizations operating in foreign markets.
33 See, e.g., Banking (Glass-Steagall) Act of 1933, 12 U.S.C. §§ 24, 377-37
banks from dealing in and underwriting securities, and limiting bank securities activities to agency
activities upon the order of their customers) [hereinafter Glass-Steagall Act]. The Glass-Steagall
Act has been the subject of extensive recent commentary, and is the subject of imminent reform.
See, eg., Norton, Up Against "The Wall" Glass-Steagalland the Dilemma of a
Deregulated("Reregulated") BankingEnvironment,42 Bus. LAW. 327 (1987); Note, The European
Community'sSecond Banking Directive: Can Antiquated United States Legislation Keep Pace?, 23 VAND. J.
TRANSNAT'L L. 615 (1990). In addition, the Treasury Report, supra note 19, proposes relaxing the
prohibitions of Glass-Steagall for certain well-capitalized banks.
34 12 U.S.C. § 24 (1988) (limiting the activities of banks to the business of banking) and 12
U.S.C. § 184
) (limiting the activities of and types of subsidiaries held by bank holding
35 The Bush administration has recently proposed a complete revision of the U.S. approach to
this separation. Treasury Bill, supra note 20. In addition, there have been a number of smaller
breaches in the Glass-Steagall wall. The most significant is the Board's approval of applications of
bank holding companies under Section 20 of the Glass-Steagall Act, 12 U.S.C. § 377 (1988), to
underwrite and deal in "ineligible" debt and equity securities. See, eg., J.P.Morgan & Co. Inc., et
al., 75 Federal Reserve Bulletin 192 (1989). For a relevant discussion of developments under Section
20, see Eisenberg, The Effect of Recent U.S. Bank RegulatoryDevelopments on Accommodating
Eustrictive,a6 especially given the growing recognition of fumgibility of bank
finance and securities finance, as well as the growing involvement in
financial sector activities by industrial companies. Simply put, as
brokerage houses, insurance companies, auto and appliance manufacturers and
other non-banks offer more and more products that compete with
traditional bank services, it has become less realistic and fair to prevent banks
from offering a broader range of financial and related services. On the
other hand, the thrift crisis has underscored the need to be wary of
deregulatory initiatives that may disturb the delicate balance between
maintaining incentives for individual initiative and responsibility in bank
management, and prudential regulation that protects the financial system
and the federal safety net from excessive risk.3 7
Thus, in connection with its separation of banking from other
businesses, the U.S. bank regulatory regime contains a significant and
earnestly-held policy difference from many foreign regulatory regimes,
including that of the Second Banking Directive, which adopts a universal
banking structure, allowing banking organizations to engage in a wide
range of securities business, as well as other business, including, subject
to certain limitations, non-financial business.3 " This difference arises
from a different economic and regulatory history, a different financial
institution structure and a different regulatory, legal and political
This difference raises two sets of issues in international finance: (i)
when U.S. banking organizations operate abroad, to what extent are they
still restricted by U.S. regulation that restricts their powers in order to
guard their safety and soundness; and (ii) will foreign banking
organizations that may engage in other businesses abroad that are not permitted
to banking organizations in the U.S. be restricted in their access to the
U.S. banking market? This is a conflict between two bases for
prescriptive jurisdiction: territoriality and nationality. The U.S. applies its rules
to its nationals (and their subsidiaries) wherever they operate, with some
amelioration for foreign operations. It also applies its rules to foreign
persons operating within the U.S. with respect to their U.S. operations
and to a limited extent with respect to their operations abroad.
Internaropean Views of AppropriateBank Securities Powers,in 1992 IN EUROPE, A PRACTICAL AND LEGAL
GUIDE TO DOING BUSINESS IN THE SINGLE EUROPEAN MARKET (1990).
36 Insofar as the abuse to which they are addressed can be prevented by less restrictive measures.
37 See, eg., Gail & Norton, A Decade'sJourney From "Deregulation" to "Supervisory
Reregulation'" The FinancialInstitutionsReform, Recovery, and Enforcement Act of 1989, 45 Bus. LAW.
38 See text accompanying notes 69-95, infra. The Second Banking Directive does not require
member states to permit banks to engage in the insurance business.
Northwestern Journal of
International Law & Business
tional law provides little well-accepted restriction on exercise of
jurisdiction on this type of overlapping basis. U.S. courts will look to the intent
of Congress in order to determine whether Congress intended a
particular statute to apply outside the U.S.3 9 The Glass-Steagall Act itself
contains no geographic limitation, nor does it or its legislative history
contain any expression of an intent to cover overseas operations. The
Supreme Court's recent analysis in Boureslan v. Arabian American Oil
Company would indicate that, given the failure of Congress to express an
intent to apply the Glass-Steagall Act abroad, it should not be so
applied.' However, the BHC Act has provisions that indicate an intent to
apply some of these principles to the operations of bank holding
companies abroad, and Regulation K, formulated by the Board, responds to
both sets of issues.
Second, commercial banks operating in the U.S. have been subjected
to severe restrictions on interstate branching and other geographical
expansion.41 These restrictions stand in sharp contrast to the thrust of the
Second Banking Directive toward extreme liberalization of geographic
restrictions on competition in banking and financial services within the
European Community. In effect, the European Community's single
market has gone the U.S.' not-quite-single market one better, by creating a
true single market in banking and financial services, while the U.S. so far
continues to limit the ability of domestic banking organizations and
foreign banking organizations to operate throughout the United States.4 2
In April 1991, in response to concerns about the competitiveness of
U.S. banking organizations in operations abroad, the Board revised
Regulation K to permit U.S. banking organizations to expand the scope of
their international activities. The Regulation K Revisions cover several
areas. The areas that will be discussed here are (i) a liberalization of the
authority of U.S. banking organizations to engage in underwriting and
dealing equity securities abroad; and (ii) a clarification of the criteria for
granting exemptions from the restrictions of U.S. banking law to certain
foreign banking organizations operating within the U.S.43 Under section
25 of the Federal Reserve Act,'W the Edge Act45 and the BHC Act, the
Board is authorized to permit U.S. banking organizations to engage in a
broader array of activities abroad than is permitted within the United
Foreign branches of U.S. banks are authorized, under section 25 of
the Federal Reserve Act, to exercise such further powers as may be usual
in connection with the banking business in the place where the branch is
located, subject to the Board's regulation, and subject to statutory
prohibitions on commercial and securities activities.4 6 Edge Act
subsidiaries of banks or of bank holding companies are permitted to engage in
such activities as may be usual, in the determination of the Board, in
connection with the business of banking or other financial operations in
the countries in which they act. 7
Section 4(c)(13) of the BHC Act4 8 provides an exemption from the
limitations on holding interests in non-banking organizations-the
limitation on the businesses that a bank holding company may engage in
through subsidiaries-imposed by Section 4 of the BHC Act for
subsidiaries that do no business in the United States, if the Board determines by
regulation or order that the exemption would not be "substantially at
variance with the purposes of [the BHC Act] and would be in the public
Although the statutory standards for the exercise of the Board's
discretion thus differ under each of these provisions, Congress clearly
authorized the Board to make compromises between the goals of regulatory
effectiveness-concerns for the integrity of the federal safety net-and
competitiveness in connection with the foreign operations of U.S.
banking organizations. It is notable that Congress gave little statutory
guidance to the Board as to how to make this compromise. Under its own
43 In addition, the Regulation K Revisions include liberalization of investments by U.S. banking
organizations under the general consent procedures (without specific Board approval), liberalization
of foreign portfolio investments by U.S. banking organizations, and increasing the scope of entities
to which Edge corporations may provide full banking services in the United States. Regulation K
Revisions, supra note 4.
44 12 U.S.C. § 604(a) (1988).
45 12 U.S.C. §§ 611, 61
46 12 U.S.C. § 604(a) (1988).
47 12 U.S.C. § 61
48 12 U.S.C. § 1843(c)(1
interpretation of these standards, set forth in Regulation K, the Board is
permitted to authorize those activities that it finds to be "usual in
connection with the transaction of banking or other financial operations
abroad," so long as the activity is consistent with the safety and
soundness of the relevant U.S. entities.4 9 Regulation K articulates the Board's
views as to what is permitted under this standard.
SecuritiesActivities of US. Banking OrganizationsAbroad under
Regulation K permits foreign subsidiaries of U.S. banks and bank
holding companies to underwrite (purchase for resale in a primary
securities offering) and deal (purchase for resale in secondary securities
transactions) in debt and equity securities outside the United States, subject to
certain limits on underwriting and dealing in equity securities."0 In its
release proposing the Regulation K Revisions, the Board recognized that
these limits on underwriting and dealing in equity securities reduce the
ability of U.S. banking organizations to compete abroad." The
Regulation K Revisions raise equity underwriting limits to the lesser of $60
million or 25% of the investor's5 2 Tier 1 capital.5 3 The prior limit was the
lesser of $2 million or 20% of the voting shares or capital and surplus of
any one issuer, although the use of multiple foreign underwriting
subsidiaries could allow a banking organization on a consolidated basis to have
commitments aggregating up to $15 million.5 4 The permission to engage
in these activities abroad, subject to limits, represents a compromise
between regulatory effectiveness and competitiveness. The expansion of the
limits represents a change in the nature of the compromise.
The Glass-Steagall Act applies domestically without benefit of these
exceptions, although it is increasingly subject to other exceptions. One
immediate question is, if the separation of commercial banking from
in49 RegulationK ProposedRevisions, supra note 4, at 96,677.
50 Regulation K, supra note 4, at § 211.5(d)(13).
51 Regulation K ProposedRevisions, supra note 4, at 96,678.
52 The "investor" would be the bank holding company, an Edge corporation or a member bank,
depending on which is the closest parent to the foreign company. Thus, where the investor is an
Edge corporation, which is frequent, the limitations on the capitalization of the Edge corporation
would limit its ability to engage in underwriting activities. Section 25(a) of the Federal Reserve Act
limits member bank investments in Edge corporations in the aggregate to 10% of bank capital. 12
U.S.C. § 61
). If a bank holding company were to invest directly in a foreign securities
subsidiary, or in an Edge corporation, this limit would not apply.
53 Tier I capital is defined in the Capital Adequacy Guidelines for State Member Banks:
RiskBased Measure, 12 C.F.R. part 208, app. A (1991).
54 The $2 million or 20% of capital and surplus or voting shares of the issuer was contained in
former § 211.5(d)(13). The ability to aggregate among multiple subsidiaries was limited by the
investment limits under § 211.5(c)(1), requiring Board consent for investments exceeding $15 million.
vestment banking is an important regulatory principle, why is it relaxed
with respect to U.S. banking organizations' operations abroad?
Competitive pressure is only part of the answer. The other part of the answer is
that this regulatory principle is increasingly discredited. A principle that
is increasingly recognized as subject to question, in part because it is not
included in foreign regulation, is compromised at the international level
in order to meet competitive pressure there." Of course, the competitive
pressure would exist at home as well, if U.S. regulation were not applied
to foreign banking organizations operating in the United States to
generally prevent them from engaging within the United States in businesses
forbidden to U.S. banking organizations. Thus, while the safety and
soundness rationale cannot support the application of these restrictions
to foreign banking organizations operating in the U.S., it is important to
apply these restrictions to these entities in order to avoid competitive
unfairness to domestic banking organizations. Idiosyncratic domestic
regulation thus leads to inapposite regulation of foreign entities to avoid
On the other hand, assuming it has been determined that allowing
U.S. banking organizations to engage in the securities business abroad on
a limited basis does not pose threats to the stability of the U.S. financial
structure, not to mention the federal deposit insurance system, sufficient
to overcome arguments based on competitive pressure, why does it
matter where the activities are carried out? It may be that the Board feels it
appropriate to limit its departures from its basic regulatory principle to
the specific competitive circumstances-foreign operations-that justify
the exceptions. In addition, the Board has stated that "decisions on the
appropriate structure for broader powers for U.S. banking organizations
should properly be made in a wider context."5 6
There is a degree of asymmetry to the Board's position, insofar as it
permits U.S. banking organizations increased powers in foreign markets,
at the same time that it continues to deny these powers to foreign
banking organizations operating in the United States. Thus, a foreign bank
might question the fairness of a liberalization that benefits only U.S.
banks operating abroad, and not foreign banks operating in the United
States, when the principle being liberalized is just as applicable abroad as
55 See text accompanying notes 78-95 for a discussion of the pressures for domestic change
arising from both (i) concerns that U.S. regulation is more restrictive than foreign regulation, and (ii)
concerns that the U.S. does not offer effective national treatment or equivalent market access
sufficient to satisfy requirements for reciprocity in connection with liberalization under the Second
Banking Directive. As discussed therein, these pressures for deregulatory harmonization challenge
longheld regulatory principles.
56 Regulation K ProposedRevisions, supra note 4, at 97,692-93.
This is an argument for mutual recognition. This approach to
mutual recognition differs from that imposed under European Community
law pursuant to the single market program and specifically under the
Second Banking Directive, insofar as it is based on "soft" law: a
discretionary approach to comity and expectations of market participants. In
this sense it is not mandatory for the United States to provide this type of
mutual recognition. However, the Commission, here and in connection
with Rule 15a-6, appears willing to provide limited mutual recognition.
The Commission has recently proposed expanding the concept of
mutual recognition significantly, in connection with tender offers,
exchange offers and rights issues.' 56 With respect to tender offers and
exchange offers, these proposals would recognize that it is inappropriate to
apply the full U.S. rules to offers with respect to which only a small
minority of shareholders are U.S. persons. This proposal differs from
Regulation S,which would call for the full application of U.S.
registration requirements in connection with a public offering where only a small
minority of purchasers are U.S. persons.
Regulation S is based on a territorial approach to the application of
the registration requirements: if the offering takes place "in" the United
States, it must be registered. If it does not, it need not. The Commission
will not apply registration requirements to protect U.S. citizens
purchasing securities abroad; such protection is unnecessary to carry out the
Commission's principal purpose. 157 The touchstone for prescriptive
jurisdiction here is where the transaction takes place, more than who the
purchaser is, although who the purchaser is may affect the complex
determination of where the transaction takes place. In accepting this
principle, the Commission accepts the idea that investors who are U.S.
citizens, by acquiring securities outside the United States, may effectively
choose to forego the protections of the registration requirements and
U.S. disclosure requirements. "As investors choose their markets, they
choose the laws and regulations applicable in such markets." 15 This
concept, though undoubtedly accurate at one level, may be inconsistent
with Section 14 of the Securities Act, 5 9 which provides that contractual
waivers of compliance with the Securities Act are void. However, in
156 International Tender and Exchange Offers, Securities Act Release No. 6897, 48 SEC Docket
(CCH) 1646 (June 5, 1991); Cross-Border Rights Offers, Securities Act Release No. 6896, 48 SEC
Docket (CCH) 1617 (June 5, 1991). For a summary of these proposals and their context, see Bartos,
A New Dealfor US Investors in Foreign Markets, INT'L FiN. L.R., July 1991, at 27.
157 We will see below that this distinguishes the Commission, and the securities laws, from the
Internal Revenue Service, and the tax laws.
158 RegulationS Release, supra note 148, at 15-16.
159 15 U.S.C. § 77n (1988).
Northwestern Journal of
International Law & Business
Scherck v. Alberto-Culver,"6 the Supreme Court held that this policy
against waivers (in the context of a similar provision in the Exchange
Act) might give way in the international context to the goal of fostering
certainty in international commerce.
This territorial approach is implemented through a general
statement to the effect that offers and sales that take place outside the United
States are not required to be registered under Section 5 of the Securities
Act,16 x and two safe harbors 162 to provide mechanisms for issuers to
achieve relative certainty that their offerings are, indeed, outside the
United States. The work that has gone into elaborating this simple
standard shows that merely stating that the principle to follow in resolving
prescriptive jurisdiction problems is territoriality does not definitively
resolve these problems. This is because territoriality includes several
concepts, including degree of territorial conduct, degree of territorial effects
and a comparison to territorial conduct and effects elsewhere. 163
Regulation S begins with a series of preliminary notes, the second of
which expresses the Commission's ambivalence about the delimitation of
regulatory jurisdiction represented by Regulation S:
In view of the objective of these rules and the policies underlying the Act,
Regulation S is not available with respect to any transaction or series of
transactions that, although in technical compliance with these rules, is part
of a plan or scheme to evade the registration provisions of the Act. In such
cases, registration under the Act is required. 164
While the Commission would no doubt protest that this type of
provision, like its analogs in the U.S. tax laws, 165 would not be used much
and is necessary to prevent abuse, a practitioner might respond that this
type of broad regulatory safety valve poses unacceptable risks to the
issuers that obviously will plan to avoid (but not evade?) the registration
requirements. Like the separation of the registration requirements from
the antifraud requirements, this ambivalence is based on regulo-centrism
160 417 U.S. 506, 517 (1974).
161 Regulation S supra note 9, at Rule 901.
162 Regulation S, supra note 9, at Rules 903 and 904. These are non-exclusive safe harbors:
compliance with one of the safe harbors allows the issuer not to register, but non-compliance does not
necessarily result in a registration obligation, so long as the requirements of the general statement are
163 See, e.g., RESTATEMENT (THIRD) OF THE FOREIGN RELATIONS LAW OF THE UNITED
STATES § 402(1) (1987), elaborating at least three approaches to territoriality, and § 403(2)(a) and
(b), describing a relativist approach to territoriality.
164 Regulation S, supra note 9, at preliminary note 2.
165 See, e.g., Treas. Reg. § 1.861-7(c) (1991), changing the "passage of title" rule for determining
the source of income from sales of inventory, by stating that where "tax avoidance" is involved, all
factors of the transaction will be considered. In the tax case, the ambivalence is between providing
clear rules and trying to avoid providing means for tax avoidance or evasion.
and an unwillingness definitively to give up the possibility of applying
U.S. regulatory principles to foreign activity.
Section 901, the general statement, has been reduced significantly
from the general statement included in the Regulation S Initial Release
and the Regulation S Reproposing Release, which contained much more
substantive guidance, including a list of factors to be considered in
determining whether an offering is offshore. The general statement as finally
promulgated merely provides that Section 5 of the Securities Act does
not apply to offers and sales of securities that occur outside the United
States. Section 902 provides a series of definitions, and Sections 903 and
904 provide safe harbors under which an offering is deemed to occur
outside the United States.
Section 903 is the safe harbor applicable to sales by issuers of
securities. It significantly liberalizes prior practice in the offshore offering area,
allowing less restricted offerings. It requires first, that the offer and sale
be made in an "offshore transaction;" second, that no "directed selling
efforts" be made in the United States by the issuer or any underwriter or
other distributor; and third, that depending on the perceived risk that
securities offered will flow back to the United States, certain safeguards
be established to cause them to "come to rest" abroad. An "offshore
transaction" is one where the offer to sell is made offshore. In addition,
for purposes of this safe harbor, either the seller must believe the buyer to
be outside the United States, or the transaction must take place through
an established foreign securities exchange.1 66 "Directed selling efforts"
means any activity that could reasonably be expected to stimulate U.S.
interest in the securities. 167 The safeguards required to be established in
order to ensure that the securities come to rest abroad depend on the
type of issuer and the type of security involved. No additional safeguards
are required in the case of securities issued by a foreign issuer for which
there is no substantial U.S. market interest, as defined.168 In addition, no
additional safeguards are required for securities sold in an "overseas
directed offering," which is an offering by a foreign issuer in a single
foreign country, or an offering by a U.S. issuer in a single foreign country of
debt securities denominated in a foreign currency. 169 For securities of
issuers required to file annual, quarterly and interim reports under the
Exchange Act, and for debt securities of other issuers, certain offering
restrictions are required, including appropriate legends on the offering
166 Regulation S, supra note 9, at § 902(i).
167 Regulation S, supra note 9, at § 902(b).
168 Regulation S, supra note 9, at § 902(n).
169 Regulation S, supra note 9, at § 902(j).
documents, and forty-day lock-ups during which the securities may not
be sold to U.S. persons. For other offerings, similar offering restrictions
are required, as well as a forty-day lock-up for debt securities and a
oneyear lock-up for equity securities, as well as buyer certifications to the
effect that they are not U.S. persons and other safeguards. 170 U.S.
personality is determined based on residency, rather than citizenship.
Section 904 is the resale transactions safe harbor for transactions by
persons other than the issuer or distributors on behalf of the issuer. It
includes the same requirement for an offshore transaction, and the same
prohibition on directed selling efforts in the United States, as Section 903.
However, it modifies the safeguards required in order to ensure that the
securities come to rest abroad, imposing on dealers in securities during
the lock-up periods applicable under Section 903 the obligation not to
sell to anyone known to be a U.S. person, and only to sell to other dealers
with a notice stating that the securities are subject to the lock-up.
Regulation S has been hailed as an advance in the certainty,
economy and logic of the U.S. regulatory approach to foreign securities
offerings. It is indeed a useful exercise in administrative determination of the
extraterritorial scope of the U.S. securities laws. One significant question
about this exercise is what statutory basis the Commission has for
delimiting the reach of Section 5 of the Securities Act. In a sense, this question
is not a new one, as it is at least as old as Release 4708. As noted above,
the Commission has made some policy choices in promulgating
Regulation S, determining that it only applies to certain parts of the securities
laws, and determining the circumstances under which it is available.
The Commission refers to Section 19171 of the Securities Act as
authority for Regulation S. Section 19 gives the Commission authority to
make such rules as are necessary to carry out the provisions of the
Securities Act. Regulation S can be evaluated against this authority in two
ways. First, it might be argued that Section 19 provides authority for
Regulation S because there are implicit in Section 5 and in the definition
of interstate commerce limits on the prescriptive jurisdiction meant to be
exercised by Congress.17 2 For example, the definition of interstate
commerce, which tracks the Commerce Clause of the Constitution, speaks of
commerce among the several states and with foreign nations, implying
that Congress did not intend to reach commerce that does not involve
170 Regulation S supra note 9, at § 903(c).
171 15 U.S.C. § 77s (1988).
172 See § 2(a)(7) of the Securities Act, 15 U.S.C. § 77b(7). The Commerce Clause of the
Constitution has similar language. U.S. CONST. ART. 1, § 8, cl. 3. For an analysis of the constitutional
arguments, see Brilmayer, The ExtraterritoriaAl pplication ofAmerican Law: A Methodologicaland
ConstitutionalAppraisal, 50 LAW & CONTEMP. PROBS. 11 (1987).
the United States. The question left unanswered by this proposition is
what does it mean to involve the United States in this world of
interdependence, arbitrage and fungibility? A plausible argument can be made
that all financial transactions, whether denominated in dollars or not,
affect the U.S. economy, at least indirectly. 173 However, this argument is
unacceptable in the international arena, and thus it is for Congress or the
Commission, or the courts, to further define the magnitude of
involvement that will be sufficient to invoke the application of U.S. laws. On
this basis, the Commission may argue that it is necessary for it to make
rules delimiting the jurisdictional reach of Section 5. Second, it might be
argued that it is necessary to delimit the ambit of the registration
requirements, because it is physically and politically impossible to apply them to
the full range of conduct that the definition of interstate commerce
Regulation S and the TEFRA D Rules: An Example of U.S.
As described above, Regulation S was intended to clarify, and to
liberalize, the extent of U.S. securities regulation of offshore offerings.
However, the liberalization actually achieved was less than expected,
because the IRS could not accept the complete liberalization that the
Commission was seeking. The IRS, and the tax laws, have different goals and
methods than the Commission and the securities laws. For example,
U.S. citizens are subject to U.S. taxation on their worldwide income
(subject to limited tax credits for certain foreign income taxes), regardless of
the fact that they may be resident abroad, whereas one theme of
Regulation S is to protect U.S. markets, rather than necessarily investors who
are U.S. citizens. In particular respects, these goals and methods
coincided for a time to make compliance with certain securities law
requirements suffice to satisfy certain tax law requirements. As the Commission
liberalized in accordance with its regulatory goals, it changed its rules in
a way that ended this coincidence of method. In order to understand this
173 This would be similar to the cumulative effects test applied in domestic interstate commerce
analysis under Wickard v. Filbum, 317 U.S. 111 (1942).
174 The Commission's authority to make rules is limited by the requirement that the Commission
act in a manner that is neither arbitrary nor capricious, and by the requirement that its rulemaking
not be in excess of statutory authority. It is appropriate to consider the question ofwhether, in light
of the statutory context, it is arbitrary for the Commission by regulation (as opposed to the exercise
of prosecutorial discretion) to divide the world for purposes of the prescriptive jurisdiction of the
registration requirements on territorial lines, but to continue to purport to apply the antifraud
provisions of the securities laws more broadly.
issue, it is necessary briefly to review the history of U.S. tax treatment of
eurobond offerings by U.S. issuers.
The U.S. Tax Reform Act of 1984 created a "portfolio interest"
exemption from the U.S. 30% withholding tax applicable on interest paid
to foreign creditors. This allowed a significant simplification of
procedures for offerings by U.S. issuers in the eurobond market." 5 Under
interpretive regulations subsequently issued by the IRS in accordance with
the bearer bond provisions of the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA), this portfolio interest exemption was available for
eurobonds in bearer form (as opposed to those that are in registered
form, meaning that they can only be transferred by a notation on the
books of a registrar or transfer agent). However, for bearer bonds,
certain safeguards are required. The IRS views the safeguards as necessary
in connection with offerings by U.S. issuers in order to prevent bearer
bonds from being purchased by U.S. investors as a means of evading
their U.S. tax obligations. Bearer bonds are particularly susceptible to
use to evade taxes, because they may be held anonymously, and the
owner may receive payments of interest and principal without revealing
his or her identity. While this concern may indeed be valid, the
restrictions placed on offerings by U.S. issuers must be insufficient to
accomplish its purpose, as the greater integration of capital markets and
fungibility of debt obligations issued by U.S. issuers with those issued by
foreign issuers means that investors should be relatively indifferent
between U.S. bearer bonds and foreign bearer bonds.
The safeguards imposed by TEFRA on bearer bonds of U.S. issuers
were a foreign issuance requirement and a foreign payment of interest
requirement: seeking to ensure that the securities were offered and sold
to non-U.S. persons, and that interest is payable only outside the United
States. 176 Issuers that do not comply with these requirements would be
denied deductions for interest payments on these bonds, and would be
subject to an excise tax. In addition, U.S. holders would be subject to
certain sanctions under U.S. tax laws, including denial of capital gains
175 For the background of these provisions, see Pergam, Legal Dimensionsof
EurobondFinancing, 1989 SMU INSTITUTE OF INTERNATIONAL FINANCE (1989).
176 IRC § 163(f)(2)(B) requires bearer bonds to comply with the following requirements in order
to avoid certain tax penalties, including denial of deductibility of interest for the issuer:
(i) there are arrangements reasonably designed to ensure that such obligation [an obligation in
bearer form] will be sold (or resold in connection with the original issue) only to a person who is
not a United States person, and
(ii) in the case of an obligation not in registered
form(1) interest on such obligation is payable only outside the United States and its possessions,
(II) on the face of such obligation there is a statement that any United States person who
holds such obligation will be subject to limitations under the United States income tax laws.
treatment and denial of loss deductions. The regulations issued under
the Tax Reform Act of 1984 elaborated the foreign issuance requirement
and foreign payment of interest requirement. 17 7
Under the 1984 regulations, the foreign issuance requirement is met
if the bonds are offered, sold and delivered outside the United States and
either (i) the issuer receives an opinion of counsel that the obligation is
exempt from registration under the Securities Act because it is intended
for distribution only to non-U.S. persons, or (ii) the offering meets a
fourpart test. The four-part test involves agreements by the distributors of
the offering that they will not offer or sell to U.S. persons (except
financial institutions under certain circumstances), requirements that the
distributors send confirmations to purchasers requiring the purchasers to
represent that they are not U.S. persons, requirements that the
purchasers certify that they are not U.S. persons in order to receive delivery of
definitive bonds, and requirements that the issuer and distributors not
have knowledge of the falsity of such certificate. The foreign payment of
interest requirement is met if interest is payable only on presentation of
an interest coupon outside the United States, and not by transfer to a
U.S. account or by mail to a U.S. address.
Regulation S could have made the first alternative means of
satisfying the foreign issuance requirement easier to meet, insofar as the first
alternative relies on the securities law test. However, the IRS was not
satisfied with Regulation S as a means of satisfying the foreign issuance
requirement, for two reasons. First, Regulation S, in a departure from
previous securities law practice, uses a residence-based definition of U.S.
person, while U.S. tax law concerns mandate a definition that covers
either citizenship or residency.' 7 Second, and perhaps more
importantly, Regulation S eliminates the need for purchaser certification of
non-U.S. personality for offerings of bearer bonds of U.S. issuers required
to fie annual, quarterly and interim reports under the Exchange Act.
The restrictions imposed on these offerings by Regulation S, as stated
above, include certain offering restrictions, including appropriate legends
on the offering documents, as well as forty-day restricted periods during
which debt securities may not be sold to U.S. persons (based on
residency), but not including certifications as to non-U.S. personality of the
177 T.D. 7965, 49 Fed. Reg. 33228 (1984); T.D. 7966, 49 Fed. Reg. 33236 (1984); T.D. 7967, 49
Fed. Reg. 33239 (Aug. 22, 1984). Amended versions of these regulations have appeared as IRS
Regs. §§ 1.163-5(c)(2)(i)(A) and (B), which have been replaced by the TEFRA D rules described
below, and as Reg. § 1.163-5(c)(2)(i)(C)), which will continue to be available under certain
circumstances for foreign issuers and foreign branches of U.S. banks.
178 IRC § 7701(30).
purchaser. Therefore, the IRS adopted independent requirements for
satisfaction of the foreign issuance requirement.
The IRS requirements-known as the TEFRA D rules17 9-were
issued on May
, two weeks after Regulation S was promulgated,
and in response to Regulation S. The principal features that distinguish
TEFRA D from prior tax regulation requirements and from Regulation
S with respect to offerings of bearer bonds-the instrument of choice in
the eurobond market-are as follows.
First, TEFRA D requires generally that no offers or sales in the
United States or to U.S. persons be made by the issuer or any distributor
during a forty-day restricted period, and that the bonds be delivered
outside the United States. The definition of "U.S. person" is based on
citizenship or residency. Thus, while Regulation S would permit an
offering of eurobonds to be made in a way that would not discriminate
between foreign persons and U.S. persons resident abroad, TEFRA D
would require such discrimination. A distributor-generally, any person
who offers or sells the securities during the 40-day restricted period
under a contract with the issuer or with a person under a contract with
the issuer-is deemed to comply with this restriction if it covenants to do
so, and has in place procedures reasonably designed to let its employees
or agents know of the restrictions.
Second, TEFRA D requires that the issuer obtain a certificate of the
owner of the bond or of a financial institution through which the owner
owns the bond, certifying that the obligation is not owned by a U.S.
person, or is owned by an eligible U.S. person or financial institution.
Regulation S requires certificates in connection with offerings of debt securities
only for U.S. issuers that are not subject to the reporting requirements of
the Exchange Act. TEFRA D contains an exception to the certification
requirement for offerings targeted to countries where certification is
expected to be impermissible under local law, subject to the satisfaction of a
number of requirements designed to indicate that the offering is targeted
to purchasers in that country. It is expected that certification will be
impermissible under the laws of Germany and Switzerland.
The TEFRA D provisions have clear statutory backing for their
restriction of offerings to U.S. persons defined by reference to either
citizenship or residence. In addition, this approach is consonant with the
jurisdictional approach of U.S. tax law: to tax all citizens and residents.
The statutory basis for the TEFRA D requirement of certification
where Regulation S would not require certification is less clear. The IRS
179 TEFRA D Rules, supra note 10.
imposed this requirement despite liberalization by the Commission in
Regulation S in a context where their immediate goals are similar: to
require that the offering is reasonably designed (using the language of the
tax law) to ensure that the bonds will not be sold to U.S. persons.
However, the underlying rationale of the securities law rule is to maintain the
protections afforded by the registration requirements (here meaning the
requirement to file a registration statement with the Commission) of the
securities law. The underlying rationale of the tax law rule is to avoid
the possibility that U.S. persons (as defined under the tax law) would use
bearer bonds to evade U.S. taxes. While the Commission is willing to
allow U.S. citizens effectively to waive the protections of the registration
requirements (but not necessarily the protections of the antifraud
provisions), it would obviously be inappropriate for the IRS to allow U.S.
persons to waive the protections against bearer bonds being used to facilitate
tax evasion. However, the TEFRA D rules significantly diminish the
benefit of Regulation S in the context of eurobond offerings, which
generally require bearer securities.
Comparison of the Approach of Regulation S to that of the
Reciprocal Prospectus Initiative and the European
Community Common Prospectus Initiative
In most markets, securities offering regulation is based on
disclosure. Multinational offerings of securities have in recent years become
common, and are recognized as an effective way to broaden the
marketing of securities, also adding stability and depth to the secondary market
for an issuer's securities. However, most countries regulate public
offerings, and each country's regulation differs, requiring varying levels and
types of disclosure, and requiring varying types of government review
processes. These variations can impede public offerings in two ways:
first, by requiring varying disclosure documents to be prepared satisfying
the requirements of each jurisdiction in which securities are to be offered,
and second, by requiring varying schedules for offerings in different
jurisdictions. These variations can thus be costly, and can raise unnecessary
uncertainty in particular transactions. Regulation S merely describes
certain circumstances under which an offering will be deemed not to take
place in the United States, and therefore will not be required to comply
with the U.S. disclosure and timing requirements. It does not address
the problem of how to proceed when a public offering is intended to take
place in the United States as well as in one or more other jurisdictions.
The unilateral U.S. initiatives and the European Community initiatives
discussed below seek to address this problem.
In 1985, the Commission proposed two methods for facilitating
multinational offerings of securities in the United States, Canada and the
United Kingdom. 180 The two methods proposed for comment were: (i)
a reciprocal approach whereby a prospectus accepted in the domicile of
the issuer of securities would be accepted in the other countries, and (ii) a
common prospectus approach, which would entail complete
harmonization of prospectus requirements, at least for multinational offerings. The
reciprocal approach, like the single banking license of the Second
Banking Directive, calls for a degree of satisfaction with the other country's
requirements-and therefore usually a degree of "essential"
harmonization-but not for complete harmonization.
The 1985 Multinational Offerings Release summarized some of the
differences in disclosure practices among the United States, Canada and
the United Kingdom. It indicated that there are substantial differences,
based on legal requirements and market practice. The U.S. requirements
are more detailed, and require certain different information. For
example, U.S. law requires that the issuer depict its business broken down into
its geographic and product business segments. Foreign issuers find this
unattractive, as it requires additional accounting expense and may
provide useful information to competitors. In addition, variations in
accounting practice result in different definitions and treatment of certain
accounting items, rendering financial statements prepared under different
accounting systems non-comparable. Finally, and perhaps most
important, the Multinational Offerings Release describes the difference in
liability for omissions and misstatements in connection with offerings. The
main difference here is in the legal system and legal culture, with far
fewer private lawsuits for securities fraud in Canada and the United
Kingdom than in the United States. These differences in disclosure
standards and liability would have to be addressed in order to implement a
common prospectus approach.
This past June, the Commission adopted a proposal for a reciprocal
prospectus approach with Canada.18 1 It hopes to extend the approach to
other jurisdictions in the future.
180 Facilitation of Multinational Securities Offerings, Securities Act Release No. 33-6568, 32 SEC
Docket (CCH) 707 (February 28, 1985) [hereinafter MultinationalOfferings Release].
181 Multijurisdictional Disclosure and Modification to the Current Registration and Reporting
System for Canadian Issuers, Securities Act Release No. 6902, 49 SEC Docket (CCH) 260 (June 21,
1991) [hereinafter MDS Release], amending Release No. 6879, 47 SEC Docket (CCH) 526 (October
16, 1990), which amended Release No. 6841, 44 SEC Docket (CCH) 56 (July 24, 1989). Canada was
chosen as the first partner because of the greater similarity between the U.S. and Canadian disclosure
and liability standards. In addition, as discussed below, the U.K. is involved with another, more
The Commission refers to this approach as a hybrid between mutual
recognition and harmonization. 1 2 It is a hybrid in the sense that it
involves a certain degree of harmonization of requirements, and a general
but incomplete effort toward mutual recognition. Mutual recognition is
qualified by a number of U.S. requirements that are imposed in addition
to the requirement for satisfaction of Canadian requirements. First,
financial statements of the issuer are generally required to be reconciled to
U.S. generally accepted accounting principles for at least the first two
years, meaning that certain items must be re-calculated in accordance
with U.S. principles. Auditors of the issuer's financial statements for at
least the most recent year would be required to comply with U.S.
standards of independence.
It is noteworthy that this approach covers only registration
requirements and requirements regarding categories of information to be
disclosed, not the application of antifraud provisions; Canadian issuers may
generally make their disclosure in accordance with Canadian law, but
will not be exempted from the rigorous U.S. antifraud rules. This
dichotomy between registration and information requirements on the one hand,
and antifraud provisions on the other, is consistent with the approach
taken in Regulation S, but it raises greater questions in the reciprocal
prospectus context. The dichotomy does not raise the problem that an
issuer would be subject to liability for failing to provide categories of
information that are not called for by the special disclosure requirements
relating to this initiative, as some commenters claimed. The liability
provisions of the Securities Act are inapplicable to any act done or omitted
in conformity with the Commission's rules.18 3 However, the disclosure
requirements under the Securities Act exist at two levels. First,
responses must be provided to the specific items required by the
appropriate registration form. An issuer will not be liable for failing to provide
information under a heading that is not called for by the appropriate
form. However, an issuer will be liable for failing to provide information
that is not specifically required, but that is nevertheless material. The
test of materiality is the U.S. test, and the pattern of liabilities and
defenses is the U.S. pattern.
Thus, a Canadian issuer is permitted to provide merely the
disclosure required by Canadian law, to the extent permitted under the rules
obligatory, exercise in harmonizing public offering regulation, in connection with the European
Community's single market program.
182 As noted above, this hybrid approach is the main theme of the European Community's 1992
initiative, and is the approach of the Second Banking Directive and other single market financial
183 15 U.S.C. § 77s (1988).
issued under the MDS Release, but is still subject to potential liability for
failing to state information, or for misstating information, deemed
material under U.S. law, and is subject, along with its underwriters, to U.S.
standards of liability. As a practical matter, Canadian issuers and their
underwriters will seek to structure their disclosure to be as protective as
possible under U.S. law. The underwriters will therefore engage in
U.S.style due diligence in order to establish this defense, and they will insist
on a level of disclosure consistent with U.S. materiality standards.
Because of this effect, the concept expressed in the MDS Release will
provide only limited, but important benefits. The benefits that it will
provide, for Canadian issuers offering in the United States and for U.S.
issuers offering in Canada, are not so much in disclosure concessions, but
in timing. The timing advantage is that a simultaneous U.S. and
Canadian offering by a Canadian issuer can proceed in accordance with the.
Canadian timing for registration and subsequent permitted sale, instead
of waiting for an independent declaration of effectiveness-the point at
which securities can be sold-in the United States.
It is also important to consider the process that the Commission
followed in negotiating this approach with its Canadian counterparts.
The MDS Release does not evidence significant regulatory compromise
on the part of the Commission. While the Commission has done an
earnest job of compromising certain procedural requirements, including
possibilities for Commission review of disclosure, the MDS Release
evidences a careful review of foreign regulation to determine whether it
satisfies all of the concerns of U.S. regulation, and to supplement the foreign
regulation with additional U.S. requirements where appropriate. This
approach is similar to that seen in connection with the Broker-Dealer
Concept Release. The principle of reciprocity is followed only to the
extent that the foreign jurisdiction-Canada-has rules that satisfy the
Commission's regulatory goals. Otherwise, a principle of harmonization,
or more accurately, of dual regulation, is followed.
European Community ProspectusDirective and Listing ParticularsDirective
The European Community has two main directives that deal with
prospectus disclosure and filing requirements in connection with public
offerings. In 1980, the Council of the European Communities adopted
the Listing Particulars Directive184 to harmonize disclosure requirements
184 CouncilDirective of 17 March 1980 Coordinatingthe Requirementsfor the DrawingUp,
Scrutiny and Distribution of the Listing Particularsto be Publishedfor the Admission of Securities to
Official Stock Exchange Listing,23 O.J. EUR. CoMM. (No. L 100) 1 (1980) (Council Directive 80/
in connection with listings on securities exchanges within the
Community. This was followed in 1987 with the Mutual Recognition
Directive, 8 5 which amended the Listing Particulars Directive to add a limited
concept of mutual recognition within the Community. This approach
was extended in 1989 with the Public Offer Directive,"8 6 which extended
the harmonization to public offerings made other than on an exchange.
The Listing Particulars Directive, as amended by the Mutual
Recognition Directive, requires member states to ensure that listings on
stock exchanges within their territories are conditional on the publication
of listing particulars, or an information sheet.1 17 The information
published is required to include certain prescribed items of information, with
variations in cases of particular issuers or special offering situations, as
well as any other information necessary for investors to make an
informed assessment of the issuer and its securities.18 8 Member states are
required to appoint a competent authority to approve listing particulars
as in conformity with the requirements of the directive before they may
be published. 1 9 The Listing Particulars Directive, prior to amendment
by the Mutual Recognition Directive, merely required relevant
competent authorities in connection with simultaneous or near simultaneous
offerings on multiple Community exchanges to use their best efforts to
coordinate requirements. Thus it made the first step of essential
harmonization, but did not take the second step of mandatory mutual
recognition of home state regulation. 90
In 1987, the Listing Particulars Directive was amended by the
Mu390/EEC) [hereinafter ListingParticularsDirective]. For a detailed description ofthe Listing
Particulars Directive and the Public Offer Directive referenced below, see Warren, RegulatoryHarmony in
the EuropeanCommunities: The Common Market Prospectus, 16 BROOKLYN J. INT'L L. 19 (1990).
185 CouncilDirectiveof22 June 1987AmendingDirective 80/390/EEC Coordinatingthe
Requirements for the Drawing-up,Scrutiny and Distributionofthe Listing Particularsto be Publishedfor the
Admission of Securities to Official Stock Exchange Listing (Directive No. 87/345), 30 O.J. EUR.
COMM. (No. L 185) 81 (1987) (Council Directive 87/345/EEC) [hereinafter Mutual Recognition
Directive]. The Mutual Recognition Directive has been supplemented by Directive 90/21 1/EEC,
CouncilDirectiveof23 April 1990 Amending Directive 80/390/EEC in Respect of the
MutualRecognition ofPublic-OfferProspectusesas Stock Exchange ListingParticulars,33 O.J. EUR. COMM. (No.
L 112) 2
) (allowing for the recognition of a public offering prospectus not only as a public
offering prospectus in other member states, but also as listing particulars where admission to listing
is requested within a short period of time).
186 CouncilDirective of 17 April 1989 Coordinatingthe Requirementsfor the
Drawing-Up,Scrutiny and Distributionof the Prospectusto be Published When TransferableSecuritiesare Offered to
the Public, 32 O.J. EUR. COMM. (No. L 124) 8 (1989) (Council Directive 89/298/EEC) [hereinafter
Public Offer Directive].
187 Listing ParticularsDirective, supra note 184, at art. 3.
188 Id. at arts. 4, 5.
189 Id. at art. 18.
190 Id. at art. 24.
tual Recognition Directive to establish requirements for mutual
recognition of home state regulation within the Community. The home state
regulation is that of the state where the issuer has its registered office, or
if it has none in the Community, where the issuer chooses.191 Once
approved by the home state, the listing particulars are required to be
accepted by the other member states without the separate approval of their
competent authorities.192 Local competent authorities may, however,
require that the listing particulars used in another member state include
information specific to the market of such state concerning income tax,
local paying agents and local publication of notices. 193
The Mutual Recognition Directive predated the reciprocity debate
that took place with respect to the Second Banking Directive, 9 4 and
therefore does not contain specific provisions regarding the conditions for
availability of the benefits of mutual recognition to issuers resident in
third states. It permits member states to restrict the application of
mutual recognition to issuers having their registered office in a member
state. It does, however, provide that the Community may enter into
agreements with third states reciprocally extending the benefits of mutual
recognition to their issuers, provided that the third states' rules provide
"equivalent protection to that afforded by this Directive, even if those
rules differ from the provisions of this Directive."'195 The Public Offer
Directive discussed below has similar provisions. 196
The 1989 Public Offer Directive is intended to extend similar
treatment in circumstances where a public offering is made but stock
exchange listings are not effected. The implementation of this directive
required intense negotiation, as previously Community law did not
require specified disclosure prior to a public offering, but only prior to a
listing on an exchange.
The Public Offer Directive requires prospectuses to be published for
all public offerings within the Community.'9 7 For public offerings of
securities that are to be listed on an exchange, the contents of the
prospectus must comply with the Listing Particulars Directive.' 9 8 It is notable
that the Public Offer Directive adopts the regulatory principle that less
detailed information should be required in connection with unlisted
offer191 Mutual Recognition Directive, supra note 185, at art. 1.
194 See text accompanying notes 69-95,supra.
195 Mutual Recognition Directive, supra note 185, at art. 1.
196 Public Offer Directive,supra note 186, at art. 24.
197 Id. at art. 4.
198 Id. at art. 7.
ings than in connection with listings, so as not to burden small and
medium-sized issuers unduly. 199 While U.S. securities laws have similar
approaches to very small offerings,2 ' 0 the general thrust of disclosure
regulation in the United States requires less information of larger, more
established issuers, or at least permits greater incorporation by reference to
periodic disclosure documents, requiring smaller, less established issuers
to provide the fullest disclosure.
The Public Offer Directive requires unlisted offerings to comply
with a less demanding disclosure list than the Listing Particulars
Directive, although it also requires that all information be provided necessary
to enable investors to make an informed decision.20 1 While prior
scrutiny of prospectuses is not required for unlisted offerings within a
particular member state, as it is under the Listing Particulars Directive for
listed securities, 2021i prior scrutiny is a condition for mutual recognition
under the Public Offer Directive.20 3 In connection with a simultaneous
or nearly simultaneous offering in two or more member states, the
competent authority of the member state in which the issuer has its registered
office, if the public offering or a listing is made in that state, is charged
with scrutinizing and approving the prospectus. One problem raised in
connection with the Public Offer Directive is that some member states do
not generally provide for prior scrutiny of prospectuses. The directive
resolves this problem by providing that in the event that such a state
would otherwise be charged with scrutinizing and approving the
prospectus, the offeror must choose another state's competent authority where
such prior scrutiny is normally effected. Subject to this condition and to
translation, a prospectus must be accepted in other member states.
One significant problem with the Public Offer Directive is the scope
of its exclusions, which are so extensive as to possibly obviate the utility
of the directive.2 04
199 Id. at preamble paragraph 12, arts. 7, 11.
200 See Rules 505 (exemption for limited offerings not exceeding $5,000,000) and 504 (exemption
for small issues not exceeding $500,000), which provide exemptions from the registration
requirements of the Securities Act. 17 C.F.R. §§ 230.504, 230.505. Rule 505 imposes no specific disclosure
requirements, although it does not provide exemptions from the antifraud provisions. See also
Regulation A under the Securities Act, 17 C.F.R. §§ 230.251-230.260.
201 Public Offer Directive, supra note 186, at art. 11.
202 Listing Particulars Directive, supra note 184, at art. 18.
203 Public Offer Directive, supra note 186, at arts. 20, 21.
204 See Warren, supra note 184, at 38-40 for an explanation of these exemptions. Excepted are
eurobonds and euroequities, private placements, small offerings, certain wholesale offerings,
employee offerings and exchange offers.
Northwestern Journal of
International Law & Business
Regulation S, the ReciprocalProspectusInitiative and the European
As noted above, Regulation S is a U.S. administrative effort to
divide up global prescriptive jurisdiction for purposes of the procedural
registration requirements of the U.S. securities laws. It determines
unilaterally under what circumstances these U.S. laws will apply to foreign
securities offerings, and under what circumstances they will not. From
the standpoint of addressing the problems raised by the contradiction
between national regulation and transnational finance, it takes a
relatively insular and introspective approach. On the other hand, instead of
addressing these problems by unilaterally determining which state's laws
shall govern, the Reciprocal Prospectus Initiative and the European
Community initiatives bilaterally or regionally seek to adopt mutual
recognition, relying on a degree of harmonization of rules: essential
harmonization, with differing standards as to what is essential. The Reciprocal
Prospectus Initiative implements limited mutual recognition, based on
limited harmony of legal standards. The Listing Particulars Directive
and the Public Offer Directive, on the other hand, take a more complete
approach, providing for complete harmonization, at least in selected
areas, and for complete mutual recognition.
These approaches are based on a relatively high degree of agreement
on regulatory purposes: requirements for adequate disclosure to support
accurate investment and capital allocation, combined with some level of
government scrutiny of disclosure practices and liability for faulty
disclosure. While public offering regulation contains a risk of regulatory
arbitrage and consequent competition in regulatory laxity, the direction of
flow is not as clearly indicated as perhaps in areas such as financial
institution powers or capital.
This article has considered several recent developments in financial
regulation. This consideration has focused on the difficult issues relating
to the sometimes countervailing substantive concerns for regulatory
effectiveness and for competitiveness in international business, as well as
the procedural concerns relating to cooperation, consistency and proper
The unilateral, regional and multilateral initiatives described in this
article all seek to address the mismatch between transnational finance
and national financial regulation. They can be viewed from at least three
First, as issues of regulatory scope, in which an earnest regula
tor seeks only to fulfill his or her regulatory mandate, without
other concerns for issues of competitiveness or cooperation;
Second, as issues of trade in services, in which regulators must
be sensitive to the trade concerns of domestic and foreign
Third, as issues of economic integration, wherein the principle
of subsidiarity-of regulation at appropriate levels-and of
competition and cooperation in regulation, as well as of the
degree to which regulation must mesh with a particular society,
are played out.
Only by considering all three of these perspectives, and by ensuring that
the process used to address international financial regulation issues
allows for negotiation taking into account all three of these perspectives,
will it be possible to develop solutions to problems of international
From a purely legal standpoint, this problem can be described as
one of regulatory scope or prescriptive jurisdiction: which country's law
should govern a particular institution or transaction? However, even if
this legal issue could be resolved, the results would not necessarily make
sense, as a multiplicity of independent regulatory regimes could be an
inefficient means of social control over increasingly transnational finance.
Global homogeneity of regulation is not necessarily optimal either, as
finance regulation must mesh with each society's particular
circumstances, and as opportunities for variation, and thus for greater
innovation and competition, in finance regulation are desirable. The initiatives
described herein illustrate a variety of procedural approaches to this
problem, and a variety of policy considerations applied. These
procedural approaches and policy considerations interact in complex ways in
The policy considerations added to domestic policy discourse in the
context of international regulation include, as noted at the beginning of
this article, the substantive considerations of competitiveness and
regulatory effectiveness, as well as the more procedural factors of cooperation
and consistency in relations with other countries. These policy
considerations influence and interface with the procedural approach adopted.
We have seen that competitiveness has played a significant role in
the formulation of Regulation K, which appears to limit the foreign
operations of foreign banks operating in the United States in order to avoid
providing better than national treatment in a way that reduces the
domestic competitiveness of U.S. banks. Regulation K also provides
expanded powers to U.S. banking organizations in their foreign operations
in a way that belies the need for powers limitation domestically, due to
competitive pressures abroad. Regulation K can be viewed as a means to
apply U.S. regulatory hindrances, to some extent, to foreign banking
organizations in their foreign operations, using as a jurisdictional basis the
fact that the foreign banking organization does business in the United
States. Thus, Regulation K fights a rearguard action against more liberal
On the other hand, the Second Banking Directive, in its operation
within the European Community, is intended to harness the liberalism of
foreign regulation as a competitive discipline on local member state
regulation. Under this aspect of the Second Banking Directive, regulatory
effectiveness is a determining factor of international financial regulation
policy only insofar as the regulatory goal sought to be achieved has been
the subject of essential harmonization; otherwise, free competition is the
determining factor. Regulation cannot otherwise be used intentionally or
unintentionally as a barrier or hurdle to foreign trade in financial
services. Regulation K is a unilateral dictate that does little to recognize the
possible merits of foreign regulation, whereas the Second Banking
Directive provides a regional process or forum for dialog and competition in
The Riegle-Garn Bill differs from both Regulation K and the
Second Banking Directive in that it explicitly is a trade measure, with no
independent regulatory role. It seeks reciprocity, based on an economic
perspective that openness by the United States is a detriment only to be
accepted in exchange for openness by the relevant trading partner. Of
course, while this type of measure may help to open foreign markets, it
(like the reciprocity provisions of the Second Banking Directive) is also
open to misuse to close domestic markets. The Riegle-Garn Bill rejects
multilateralism (as through the GATT) as the appropriate approach to
opening foreign markets.
On the other hand, Rule 15a-6 and Regulation S appear devoid of
trade motivation: the Commission appears as earnest regulator, merely
trying to protect the integrity of the U.S. capital allocation mechanism.
However, by attaching significant U.S. legal consequences to what may
be relatively insignificant U.S. contacts, without adjustment, they place
burdens on international finance. Rule 15a-6 appears more problematic
in this regard, as it relates to institutional-broker-dealer-regulation, as
opposed to Regulation S, which relates to transactional regulation. On
the basis of a single U.S. relationship, a foreign broker-dealer could be
required to comply with the full panoply of U.S. broker-dealer
regulation. The Commission has shown an interest in moving away from this
type of result in its recent proposals relating to tender offers and rights
offers, but has not been under similar pressure to relinquish jurisdiction
in other areas. The Commission has been motivated by a broad trade
consideration: enhancing the competitiveness of the U.S. economy as a
whole, and of U.S. investors in particular, by providing greater access to
outside sources and uses of finance without prejudicing capital import
neutrality by imposing U.S. regulatory costs on transactions that are
Regulatory effectiveness is linked with competitiveness. It appears
that the ability to maintain and apply regulation that is in excess of the
regulation of other countries, which may be viewed as a category of
regulatory effectiveness, is increasingly sacrificed to achieve greater
competitiveness and greater cooperation with other countries. This makes sense,
but also raises some concerns. The concerns are for the diminished
ability to achieve the appropriate social goals of regulation, whatever they
One way in which the ability to achieve the goals of regulation is
diminished is through regulatory arbitrage, the shifting of assets or
operations in a manner designed to minimize the costs or effects of regulation.
Regulatory arbitrage is self-conscious structuring of assets or operations.
But even without self-conscious structuring, the increasing
internationalization of business makes it harder for a single regulator to apply its rules
in a way that is effective to achieve the relevant goals, or to supervise and
enforce compliance with its rules. The BCCI scandal has been cited as
an instance of failure to coordinate supervision effectively in the face of
self-conscious structuring to avoid supervision. One prong of the QFBO
test contained in Regulation K, and part of the test for mutual
recognition under the Broker-Dealer Concept Release, seeks to ensure that local
persons are not using a foreign vehicle to shop for a less costly regulator.
The Second Banking Directive contains this concept as well.
Of course, not all regulation is good; some was not accurately
formulated when made, some is outdated and some seeks to achieve goals
that may not be appropriate, such as subsidization of a particular
business. Unless an explicit or implicit dialog with foreign regulators is
maintained, the discipline and ideas that can help reform domestic
regulation will not be available. Thus, the negotiations toward cooperation
can help each regulator to re-examine its own approach in light of the
experience of others. In this sense, cooperation both facilitates and
requires the compromise of idiosyncratic regulatory principles.
Even if all regulation were good, it is important to recognize that
overlaps of regulation--double regulation-may impose excessive costs
on enterprise. Yet until clear conflict of law rules for regulators are
formulated, as the European Community and the Basle Committee have
sought to do, these costs cannot be eliminated. The willingness of the
United States to project its regulation abroad to cover the foreign
activities of its persons or persons who have other links to the United States
diminishes the ability of other countries to provide capital import
neutrality in their regulation. The failure of international law, of the U.S.
Constitution and of many statutes to provide clear conflict of law rules
for regulators results in these overlaps.
The failure of law to provide clear conflict of law rules for
regulators, and the failure of U.S. regulators to coordinate more completely to
present an integrated view of the scope of U.S. regulatory jurisdiction,
results in possibilities for confusion and opportunism. This coordination
is enhanced by coordination between the Basle Committee and
IOSCO. 20 5
Regulation K applies U.S. bank regulation to overseas operations of
U.S. banking organizations on the basis of U.S. nationality or U.S.
nationality of shareholders, and applies U.S. bank regulation to overseas
operations of foreign banking organizations on the basis of U.S.
operations. Obviously, this approach results in overlap. Rule 15a-6 purports
to apply U.S. broker-dealer regulation to an entire foreign broker-dealer
organization, despite only a small amount of U.S. business. The overlaps
seem more problematic in the area of institutional regulation than in the
area of transactional regulation, such as the registration requirements
under the Securities Act.
Regulation S would apply the U.S. registration requirements to a
public offering where only a small portion of the shares are publicly
offered in the United States; this approach also will result in overlapping
public offering regulation. In addition, while Regulation S clarifies the
conflict of law rules with respect to the registration requirements, it
declines to provide any guidance as to the applicability of the antifraud
205 See, e.g., Thomson's Int'l Banking Regulator, Sept. 27, 1991, at 1 (reporting coordination
between IOSCO and the Basle Committee on capital requirements for securities operations of banks
and brokerage houses, as they relate to foreign exchange exposure).
provisions of the securities laws. The Reciprocal Prospectus Initiative
has a similar shortcoming.
In addition, a deeply held principle of U.S. tax jurisdiction is that
U.S. citizens should be subject to taxation on their worldwide income,
regardless of foreign residence. This principle was inconsistent with the
focus of Regulation S on the residence, rather than the citizenship, of
purchasers of securities. The maintenance of this principle has reduced
the utility of Regulation S as a means to provide unilateral conflict of law
rules with respect to the registration requirements under the Securities
Act and thereby enhance capital market efficiency, because the TEFRA
D tax requirements call for more extensive and burdensome procedures.
The procedural approaches to cooperation are determined by the
context in which the cooperation is developed: (i) unilateral without
reciprocity requirements, such as Regulation K, Rule 15a-6 or Regulation S;
(ii) unilateral with reciprocity requirements, such as the
externally-oriented features of the Second Banking Directive or the features proposed
to be added-to U.S. law by the Riegle-Garn Bill; (iii) bilateral reciprocal
agreements, such as the U.S.-Canadian multijurisdictional disclosure
system; (iv) regional with the constitutional and institutional infrastructure
of the European Community, with no conditions or opportunities for
defection based on reciprocity; and (v) multilateral non-binding, loosely
reciprocal agreements in the Group of Ten or in IOSCO. The GATT
services negotiations constitute another forum. Additional variations are
of course possible.
As indicated above, cooperation with foreign regulators requires a
recognition of the mutability of domestic regulation: a denial of
regulocentrism. It also opens up the contingency of domestic regulation, and
allows its re-examination in light of foreign experience.
The underlying difficulty in this exercise is in identifying the
appropriate social goals of regulation. Those goals that are easier to
universalize, such as disclosure regulation in the securities field, or capital
regulation in banking, may be the basis for cooperation that can alleviate
concerns for regulatory effectiveness by maintaining agreed standards, or
by providing for assistance in surveillance and enforcement. In order to
achieve cooperation, it is necessary to resolve regulation, not to its lowest
common denominator, but to its most efficient commonly acceptable
level. However, efficiency is determined by reference to the ability of
regulation to achieve social goals, and each country will have differing
social goals, depending on a variety of factors. On the other hand, some
types of goals are universal, and some types of institutional or legal
means of achieving those goals are more efficient than others. The
institutional and constitutional infrastructure of the European Community,
and its common goals of integration, provide impetus for accelerated
universalization within the Community, which in turn enhances the
ability to cooperate internally. This institutional and constitutional
infrastructure includes the ability to legislate and adjudicate member state
defections from the principles of free movement of capital and free trade
in services. It may be compared with the soft legislation and non-existent
adjudication capacities of the Group of Ten and of IOSCO, and with the
weak legislative and adjudicative capacities of GATT.
The mode and potential success of cooperation will depend on
factors such as the degree of universality of goals, the severability of the area
of regulation from other aspects of social structure, the type of regulation
involved, perceptions as to its importance for sovereignty and importance
for local control, and the institutional and constitutional infrastructure
Finally, as enhanced cooperation requires the compromise and
resolution of domestic regulatory goals and methods, it is necessary that
cooperation be effected at the level of authority competent to do so.
Neither the Commission nor the Board has been delegated full
competence to do so, nor should they be. Rather, they should cooperate with
other administrative organs to propose treaty or legislative solutions. It
is for Congress to determine how our policies should be compromised in
order to integrate our economy with the international system.
Finance is central to enterprise. As more countries move to free
their enterprise, they must also free their finance. The free transnational
flow of finance, and thus of enterprise, will help to spread jobs and
wealth, as well as to increase aggregate wealth. This phenomenon can be
facilitated by a dove-tailed effort to diminish regulatory barriers to the
free flow of capital and to enhance the accuracy of the allocation of
capital through efficient regulation.
1 12 U .S.C. § 1841 et seq . ( 1988 ).
2 15 U .S.C. § 77a et seq . ( 1988 ).
3 15 U .S.C. § 78a et seq . ( 1988 ).
4 12 C.F.R. § 211 ( 1991 ) [hereinafter RegulationK]. The Board of Governors of the Federal Reserve System proposed certain changes to Regulation K on August 1 , 1990 . 12 C.F.R. § 211 , Docket No . R- 0703 , 55 F .R. 32423 , Aug . 9, 1990 , CCH FED. BANKING L. REP . [Current] 88 , 208 ( 1990 ) [hereinafter Regulation K ProposedRevisions] . With limited modifications , these revisions were adopted on April 19 , 1991 . 12 C.F.R. § 211 , Docket No . R- 0703 , 56 F .R. 19549 , Apr . 29 , 1991 , CCH FED. BANKING L. REP . [Current] 88 , 444 (release) and CCH FED . BANKING L. REP.
31 , 411 et. seq. ( 1991 ) (revised regulation) [hereinafter Regulation K Revisions] .
5 12 U .S.C. § 601 et seq . ( 1988 ).
6 12 U .S.C. § 615 et seq . ( 1988 ).
7 17 C.F.R. § 240 .15a- 6 ( 1990 ). See text accompanying notes 97-122 , infra.
8 15 U .S.C. § 78o(a) ( 1988 ).
9 RegulationS-Rules Governing Offers and Sales Made Outside the United States Without RegistrationUnder the SecuritiesAct of1933, 17 C.F.R. 230 . 901 - 904 ( 1991 ) [hereinafter RegulationS] .
10 Treas. Reg. § 1 . 163 -5 (c)(2)(i)(D) ( 1991 ).
11 15 U.S.C. § 77 (e) ( 1988 ).
19 Department of the Treasury, Modernizing the Financial System: Recommendations for Safer, More Competitive Banks ( 1991 ) [hereinafter Treasury Report] . The Treasury Report , or at least a study of the federal deposit insurance system, was mandated by § 1001 of the FIRREA, 12 U .S.C. § 1811 ( 1989 ).
20 S. 713 , 102d Cong., 1st Sess . ( 1991 ) [hereinafter Treasury Bill] . This bill has been the subject of intense debate, and at the date of this article, had not been passed in any form .
21 Treasury Report, supra note 19 , at ix.
39 The Supreme Court, in Boureslan v. Arabian American Oil Company, 111 S. Ct . 1227 ( 1991 ), has recently held that certain statutory U.S. civil rights (under Title VII of the 1964 Civil Rights Act) are inapplicable to the activities of U.S. businesses operating abroad, as Congress did not evince sufficient intent that they be so applicable. This has been viewed by some commentators as a challenge to Congress to clarify the extraterritorial reach of these provisions .
40 111 S. Ct . 1227 ( 1991 ).
41 McFadden Act , 12 U.S.C. § 36 ( 1988 ) (limiting branching by national banks) . In addition , 12 U.S.C. § 1842(d) (1988), the "Douglas Amendment" to the BHC Act, imposes limitations on the ability of a bank holding company to acquire an out-of-state bank, unless permitted by the laws of the other state. The latter restrictions are made less problematic by state statutes that permit such acquisitions . See Shoenhair & Spong , Interstate Bank Expansion: A Comparison Across Individual States, in BANKING STUDIES, FEDERAL RESERVE BANK OF KANSAS CITY 1-23 (1990), for a description of various state laws regarding interstate banking .
42 The Treasury Report, supranote 19 , proposes extensive liberalization of restrictions on interstate banking.