The SEC Response to Internationalization and Institutionalization: Rule 144A Merit Regulation of Investors

I. INTRODUCTION As a response to the internationalization(1) and institutionalization(2) of the world's financial markets, the Securities and Exchange Commission (SEC or the Commission) adopted Rule 144A of the Securities Act of 1933 to facilitate the purchase of foreign securities in the United States by institutional investors. (3) Specifically, Rule 144A establishes, for qualified institutional buyers, a non-exclusive safe harbor from the section 5 registration requirements of the Securities Act of 1933(4) for the resale of privately placed and other restricted securities. (5) The Rule is used extensively as an exemption from registration for distributions as underwriters acquire the securities from issuers in private placements and resell the securities to qualified institutional buyers. In effect, the manner in which investors qualify as Rule 144A institutional buyers exclusively determines who may participate in the most important market for foreign securities in the United States. Rule 144A is noteworthy not only for creating a new marketplace for institutional investors but also for preserving the possibility that future federal securities regulation will focus on the merit regulation of investors. (7) The federal securities laws were adopted to protect investors through requiring the disclosure of material information by investors and insuring the verity of that information through anti-fraud provisions. In the Rule 144A marketplace, the SEC limits participation to large sophisticated institutional investors ("qualified institutional buyers"). (8) Restricting market participation to only those investors sufficiently sophisticated or able to bear substantial risk obviates the need for time-honored disclosure and anti-fraud provisions, perceived as needed mostly for individual and small institutional investors. This Note examines merit regulation of investors under Rule 144A as the SEC's response to the internationalization and institutionalization of the U.S. capital markets. Part Il provides the framework for analysis by examining the U.S. private placement market, the internationalization of the U.S. capital markets, and the intricacies of Rule 144A. Part Ill analyzes two policy rationales of the Rule: the encouragement of increased foreign participation in the U.S. securities market and the ability of sophisticated institutional investors to fend for themselves. Part Ill concludes that the policy rationales of the Rule's system of investor qualification are unsound. Thus, Part IV explores two alternatives to Rule 144A merit regulation of investors. The first alternative considers whether investors would receive more effective protection through the increased regulation of institutional investors and the establishment of sophistication requirements in all federal. securities transactions, The second alternative explores whether relaxation of investor qualification in the Rule 144A marketplace and in other areas of federal securities regulation would promote the interests of all investors. The Note concludes that all investors would benefit from relaxation of investor qualification and a reexamination of the appropriate level of regulation through the disclosure, anti-fraud, and anti-manipulation provisions of federal securities laws. II. BACKGROUND Before one can practically assess Rule 144A's adaptations to internationalization and institutionalization, it is necessary to understand the pre-existing private placement market, the impact of foreign participation in the U.S. capital markets, and the Rule's specific provisions. A. The U.S. Private Placement Market Congress enacted the Securities Act of 1933 to protect investors by requiring issuers to provide current financial and other material information. (9) The registration requirements of section 5, which mandate extensive informational filings with the SEC before securities may be issued, are integral to the Act's system of investor protection. …