Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation

Northwestern Journal of International Law & Business, Apr 2013

Trachtman, Joel P.

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Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation

InternationalFinancialRegulations Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation Joel P. Trachtman 0 1 0 ThisArticleisbroughttoyouforfreeandopenaccessbyNorthwesternUniversitySchoolofLawScholarlyCommons.Ithasbeenacceptedfor inclusioninNorthwesternJournalofInternationalLaw&BusinessbyanauthorizedadministratorofNorthwesternUniversitySchoolofLawScholarly Commons 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 Competitiveness, Effectiveness, 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 other features. 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 European Community). 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 adequacy. 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 goals. 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 9, 1991 ), indicating that talks on financial services trade is "quite far advanced," based on two similar proposals to enhance requirements for national treatment. 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 context. 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 scope. 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). 12:241(1991) 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 direct. 16 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 1 (1988 ). 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 20, 1991 , 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 reciprocity. C. Cooperation 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 competitors. 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). 12:241(1991) 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. E. 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 U.S.C. § 6a (1988 ). 26 See, e.g., Sachs, The InternationalReachof Rule l0b-5: The Myth of CongressionalSilence, 28 COLUM. J. TRANSNAT'L L. 67 7 (1990 ). 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 appropriate. 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 BANKING DIRECTIVE 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) 7 (1990 ) (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 8 (1988 ) (prohibiting 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 3(a) (1988 ) (limiting the activities of and types of subsidiaries held by bank holding companies). 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 culture. 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. 1103 (1990). 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 States. 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 interest." 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 1(a) (1988 ). 46 12 U.S.C. § 604(a) (1988). 47 12 U.S.C. § 61 5(a) (1988 ). 48 12 U.S.C. § 1843(c)(1 3) (1988 ). 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 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 5(c) (1988 ). 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 competitive unfairness. 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 12:241(1991) 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 met. 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). 12:241(1991) 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 reaches. 174 Regulation S and the TEFRA D Rules: An Example of U.S. Regulatory Disharmony 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. 12:241(1991) 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, and (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). 12:241(1991) 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 4, 1990 , 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. 12:241(1991) 1. ReciprocalProspectusInitiative 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 regulation initiatives. 183 15 U.S.C. § 77s (1988). 12:241(1991) 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 4 (1990 ) (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. 12:241(1991) 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. 192 Id. 193 Id. 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 Community ProspectusInitiatives 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. V. CONCLUSION 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 authorization. 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 perspectives: 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 constituents; and 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 financial regulation. 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 each case. 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. A. 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 foreign regulation. 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 regulation. 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 essentially foreign. B. Regulatory Effectiveness 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 may be. 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 12:241(1991) 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. D. 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 for cooperation. 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.


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Trachtman, Joel P.. Recent Initiatives in International Financial Regulation and Goals of Competitiveness, Effectiveness, Consistency and Cooperation, Northwestern Journal of International Law & Business, 2013,