Structured Thoughts: News For The Financial Services Community, Volume 4, Issue 14

Launching an Exempt Structured Products Program in the United States: Issues for Non-U.S. Banks to Consider

Non-U.S. banks that maintain a registered medium-term note program may wish to supplement that platform with an exempt bank note program for issuances of structured products. Other non-U.S. banks may wish to make the plunge into the U.S. market for the first time. Alternatively, a non-U.S. bank may have an existing exempt program, but has never contemplated using that program for issuances of structured products. In this article, we summarize the key issues to be considered prior to launching an exempt structured products program.

Which exemptions are available, and is there any advantage to using any particular exemption?

Foreign banks may avail themselves of three exemptions from registration under the Securities Act of 1933 (the "Securities Act"). Rule 144A under the Securities Act ("Rule 144A") and Regulation D under the Securities Act ("Regulation D") are both transactional exemptions available to a non-U.S. bank or any other issuer, regardless of its business.1 Regulation D is a safe harbor for private placements under Section 4(a)(2) of the Securities Act. There are significant restrictions on transfer and resale for Rule 144A or Regulation D securities. Section 3(a)(2) under the Securities Act is an exemption for securities issued or guaranteed by a "bank." It is available for securities issued by certain U.S. branches or agencies of a foreign bank, but not to the securities of the foreign bank, except as discussed below.2 The Securities and Exchange Commission (the "SEC") deems a branch or agency of a foreign bank located in the United States to be a "bank," as defined in Section 3(a)(2), provided that the nature and extent of federal and/or state regulation and supervision of the particular branch or agency is substantially equivalent to that applicable to U.S. federal or state banks doing business in the same jurisdiction.

The securities of a foreign bank are exempt under Section 3(a)(2) if they are guaranteed by a bank. Many non-U.S. banks use this structure by having the U.S. branch or agency guarantee securities issued by the non-U.S. headquarters or branch. Another alternative is to have the U.S. branch or agency act as the guarantor for securities issued by a finance subsidiary of the foreign bank. The guarantee is a legal requirement to qualify for the exemption; investors will typically not be looking to the U.S. branch or agency for payment, but rather to the home office. The guarantee must be full and unconditional.

Section 3(a)(2) bank securities have no investor or resale limitations, except as discussed below. Section 3(a)(2) bank securities are generally freely transferrable and "public," as opposed to "private" securities issued under the Rule 144A or Regulation D transactional exemptions.

Why might a non-U.S. bank consider an exempt program in addition to an existing public program?

Any bank that already issues under a registered program may consider whether an exempt program would simply be redundant, or actually provide benefits to it. Among the reasons why many issuers maintain an exempt program in addition to their registered program are:

Particularly in the Rule 144A market, some investors wish to keep the terms of the securities that they purchase confidential, which is not feasible in connection with a registered offering. Some types of underlying assets are not contemplated by the SEC's "Morgan Stanley" no-action letter relating to registered structured notes, including credit-linked notes and small-capitalization stocks. Practitioners generally believe that the potential for federal securities law liabilities in the event of a misstatement or omission in the offering documents is somewhat reduced in the case of an exempt offering. This feature might be particularly attractive in the case of complex securities or complex underliers that are used in an offering sold to institutional investors. Does the foreign bank need to consult with any U.S. regulator prior to launching the program?

A foreign bank issuing under the Rule 144A exemption or the Regulation D safe harbor would not have to consult with, or be regulated by, any U.S. regulatory entity prior to issuing its securities, nor would it have to use a U.S. branch or agency to issue under those exemptions.

A U.S. branch or agency of a foreign bank should consult with its state and federal regulator prior to launching a structured product program. U.S. branches or agencies that have chosen to be regulated as a state bank (typically in New York) should consult with their state banking regulator, the New York State Department of Financial Services (the "NYDFS"), and the Federal Reserve Bank of New York.

There are no formal federal or New York state bank regulatory application, registration or notification requirements for the issuance of notes by a New York branch. However, advance consultation with the NYDFS on any structured notes program should be considered. The NYDFS may want the opportunity to review these types of programs, and to approve/not object to the terms and conditions of the program or a proposed offering./p>

Branches or agencies in other states should contact their state and federal regulators.

If the U.S. branch's or agency's primary regulator is the Office of the Comptroller of the Currency (the "OCC"), the program must comply with 12 C.F.R. Part 16, the OCC's Securities Offering Disclosure Rules (the "OCC Rules"), as more fully discussed below. U.S. branches or agencies that have elected to be federal branches or agencies are regulated by the OCC.

An uninsured state-regulated U.S. branch of a foreign bank is subject to the deposit regulations of the International Banking Act of 1978, as amended.4 Some types of notes issued by a state-regulated U.S. branch of a foreign bank could be viewed as a "deposit" by the branch's state or federal regulators within the meaning of Section 3(l) of the Federal Deposit Insurance Act.5 In order to avoid being considered a prohibited retail deposit of an uninsured domestic branch of a foreign bank, those types of deposits cannot be offered in denominations that are less than the "standard maximum deposit insurance amount," which is currently $250,000.6 This limitation does not apply to notes issued by a foreign bank and guaranteed by its U.S. branch, and accordingly, that structure is more typically used for programs that are not planned to be limited to institutional investors.

Comparable requirements are applicable to an uninsured U.S. branch that is regulated by the OCC under the OCC's deposit-taking rules.7 These restrictions are subject to a variety of exceptions set forth in the OCC's rules. The OCC is also authorized to grant exemptions to these limitations if the branch can demonstrate that the proposed activity is consistent with the policy of according foreign banks competitive opportunities equal to those of U.S. banks described in 12 C.F.R. § 28.16(a).

Are there any restrictions on investors?

Foreign banks and U.S. branches or agencies issuing notes under Rule 144A must sell only to "qualified institutional buyers," as that term is defined in Rule 144A(a)(1) ("QIBs"). Sales to individual retail investors are prohibited. Notes sold under Rule 144A also have significant restrictions on transfer; resales to other QIBs are allowed, but transfers to non-QIBs are subject to significant restrictions, which often prevent these transfers from occurring.8 General solicitation can now be used in a Rule 144A offering, but sales can only be made to persons that the seller and any person acting on behalf of the seller reasonably believe are QIBs.9

Foreign banks and U.S. branches or agencies issuing structured notes under Rule 506 of Regulation D can sell to an unlimited number of "accredited investors," as that term is defined in Rule 405 under the Securities Act, and up to 35 non-accredited investors who meet certain "sophistication" requirements,10 if the appropriate resale limitations are imposed, any applicable information requirements are satisfied and the other conditions of the rule are met. General solicitation is now permitted in certain Rule 506 offerings, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify that the purchasers of the securities are accredited investors. A foreign bank can opt to issue structured notes under Rule 506 without using general solicitation.

Whether or not general solicitation is used in a Rule 506 offering, the new "bad actor" disqualification provisions will apply. These provisions prohibit issuers and others such as underwriters, placement agents, directors, executive officers, and certain shareholders of the issuer from participating in a Rule 506 offering if they have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws.11

Structured notes issued under Rule 144A or Rule 506 of Regulation D are "restricted securities," as that term is defined in Rule 144(a)(3) under the Securities Act, and are subject to restrictions on resale.

There are no minimum denomination requirements for a Rule 144A or Rule 506 offering of structured notes; however, concerns about preventing confusion between bank deposits and deposit products and bank notes may cause banks to issue in denominations of at least $1,000. In addition, many bank notes are issued in higher denominations, in order to help address investor suitability concerns.

A U.S. branch or agency that is regulated by a state, rather than the OCC, can issue Section 3(a)(2) bank notes to all investors, including retail. However, an agency of a foreign bank subject to New York state banking regulations would have to notify the Superintendent of the NYDFS of the upcoming transaction, and, absent objection from the Superintendent within...