Rule 144A Issues For Latin American Companies

Securities markets in Latin America, particularly Brazil, had an excellent year in 2007 and are continuing to attract overseas interest in 2008. Using Rule 144A under the Securities Act, local companies are sourcing private placements chiefly from US-based institutional investors. Furthermore, in August of last year, the US Securities and Exchange Commission (SEC) laid the groundwork for improved efficiency and transparency by approving NASDAQ’s new centralized negotiating and trading framework for securities issued under the rule. Considering that 144A was designed to draw in foreign issuers and create more liquidity, this is a positive development for the US private placement market. It has also catalyzed the prospect of IPOs for Latin American companies by acting as a mid-way point to a full listing, and regulatory updates have been developed in order to smooth that process.

Increasing numbers of Latin American companies are tapping into the US private placement market under Rule 144A under the Securities Act. The rule permits the resale of certain securities in the US to qualified institutional buyers, but does not require them to be registered with the SEC. The resale of those securities is only permitted by investors who have assets worth $100m or more, and the issuing company must have no more than 499 stockholders. This makes it attractive to these companies who were formerly discouraged from such action by liability concerns, compliance costs and the additional costs involved in selling on restricted securities. Francisco Acuna, a partner at Manatt Jones, believes that the current level of activity and deal sizes of Rule 144A issuances are highly relevant. “There is an increased interest from global investors in investing in Latin American corporate bonds. The expectations on Latin America have been increasing, and Latin American governments and companies, in general, are much more sophisticated than in the past. With the right access to information and advisers, the margins of returns in Latin America can be very high.”

Since 2001, the market for Latin American corporate new issues has doubled in size to around $65bn from $29bn. There were 177 separate issues last year. Brazil, which has an 80 percent share of Latin American equity markets, raised $23.2bn from 60 deals in the first seven months of 2007, followed by Colombia with five deals totaling $1.3bn. The use of Rule 144A in the region spans several countries and sectors, as Mr. Acuna points out. “Although two thirds of the index is made up of issues from Latin American corporations, it also includes issues from quasi-sovereign entities on the commodities sectors, such as copper in Chile, Pemex in Mexico, and Petrobras in Brazil. The more active countries have been Brazil and Mexico. There is a new interest on infrastructure development in the region, and thus, the number is expected to increase in the short term,” he says.

Besides the attraction of Rule 144A for the resale of certain securities without SEC registration, the rule offers another central but often overlooked advantage. In specific situations, offerings under the rule can form part of the funding package for project finance transactions. “144A offerings have been used as a diversified funding source for project finance transactions, for example, 144A bonds securitized by toll road revenues,” says Jose Moran, a partner at Baker & McKenzie. “Bonds may be part of a financing package that includes bank debt. The use of this funding source will depend on the market conditions, the country credit risk, the underlying credit risks associated to the party that will be servicing the debt and consequently, the successful issuance will depend on the foreign appetite for investment, the project timing and the need for funds.”

Evidently, Rule 144A was a masterstroke by the SEC, as it gave foreign companies around the world more reasons to take advantage of the US’ private placement market. “There are several advantages, all which give more flexibility,” observes Mr. Acuna. “First, there are no detailed disclosure requirements and initial purchasers. Second, they can be completed quicker than IPOs as the offering memorandum is not reviewed by the SEC. Finally, the company does not become subject to the periodic reporting obligations of the US securities laws.” Removing the requirement for public registration allows the company to access US capital at a fraction of the cost of a US-based IPO, although many companies will successfully complete an IPO at a later stage. In addition, the whole process has become easier, and more efficient, thanks to NASDAQ’s new trading and negotiation system for 144A issues. The new platform is an extension of NASDAQ’s portal system, and is the first centralized electronic system for displaying and accessing trading interest in 144A securities. With even more time, capital and flexibility, companies will have all the resources they need to grow their business and gain market experience.

However, there are also certain disadvantages. By restricting the resale of securities to Qualified Institutional Buyers (QIBs), such as insurance companies, pension funds, banks and investment companies, who are in turn subject to limitations with regards to how much they can invest in restricted securities, the market for Rule 144A issues is much less liquid than the wider public markets. Furthermore, it is common for these investors to request higher yields than would be typical in an investment outside of Rule 144A.

Regulatory and structural trends
Foreign securities resold in the US under Rule 144A typically take the form of offshore public offerings with underwriters from various countries, although many are offered in the home country using local underwriters and procedures. As for the securities, which can take the form of equities or bonds, non-convertible bonds comprise the majority of Rule 144A issues. “Latin American companies wishing to become a traditional debt issuer with debt securities registered with the SEC, as a first and prior step, will complete a Rule 144A offering combined with an exchange offer,” explains Mr. Moran.
“Since QIBs prefer the debt securities to be as freely tradable as possible, they generally request that the issuer offers to exchange the restricted debt securities for ‘freely tradable’ debt securities after closing. To ensure that the debt securities to be issued in the exchange offer are freely tradable, the issuer needs to register the exchange offer with the SEC, on a Form F-4 Registration Statement. The terms and conditions of the new debt securities will be the same as the restricted debt securities, but they will have been registered with the SEC and therefore freely tradable.”

Selling the securities to QIBs, or a person or entity reasonably believed to be a QIB, is one of the most important requirements in a valid Rule 144A transaction. Furthermore, the QIB must be aware that the sale is being conducted without making an SEC filing. Also, the securities must be of a different class to any other securities listed on a US exchange when issued. Finally, if the issuer is not a reporting company, or exempt from reporting under US securities rules, then the holder or the purchaser must have the right to obtain pertinent information about the business and its financial statements.

In terms of liability, one of the more important aspects when undertaking a Rule 144A offering is Rule 10b-5, which was designed to assist limitations on insider trading, as set out in Rule 144 itself.

Essentially, it holds an issuer liable if it knowingly provides false statements on material facts, or fails to provide material facts when required for a true representation of the situation. Issuers and investment bankers are liable under 10b-5, and as a result, due diligence and disclosure should follow the SEC format. “Due diligence encompasses not only reviewing of documents by attorneys, but also interviewing senior management regarding the business in the context of the drafting of the offering memorandum, as well as discussing the financial history and prospects of the issuer,” explains Mr. Moran. “This process is very important to ensure that the issuer and its officers and directors can defend themselves to the full extent possible, in both a civil and criminal sense, against Rule 10b-5 claims. It is also important since the attorneys will be required to provide what is generally referred to as a ‘10b-5 legal opinion’ to the company and the investment bankers, stating that the information is accurate in all material respects and does not omit any material information that should be included to ensure the information is not misleading.” As such, it is imperative that the manner of due diligence is well planned, so that the legal team, accountants, and investment bankers can ward off potential liabilities.

Rule 144A has been a powerful catalyst for foreign investment in the US private placement market, and it would seem that most of the recent developments surrounding the rule have been designed to make the process faster, easier and more efficient. This is ample consolation for the restrictions surrounding the movement of securities, particularly as many Latin American companies have used 144A as a stepping stone to a US-based IPO. In these uncertain times, maintaining a flow of deal activity and liquidity is more important that ever. This has been aided by the conventions and regulations surrounding 144A, and scope for abuse is slim at best. For both Latin America and the US, Rule 144A has created a conduit of wealth and stability for both regions over the next few years.

Contributor: Francisco Acuña

As published in the Financier Worldwide. For more information about the Financier Worldwide, please visit their website at www.financierworldwide.com.