New ADR Policies Pose Problems for Foreign Issuers
January 5, 2009
Amendments to the rules that exempt foreign stock issuers from U.S. reporting requirements have made it easier for banks to set up unsponsored American Depositary Receipt (ADR) programs. But for non-U.S. companies the new policies could prove to be a mixed blessing.
Under the revised Rule 12g3-2(b) of the Securities Exchange Act, foreign firms automatically qualify for a reporting exemption if they meet certain trading and Web disclosure requirements. Previously, they had to apply with the Securities and Exchange Commission. The change has allowed depositary agents Bank of New York Mellon Corp., JP Morgan Chase & Co., Citigroup and Deutsche Bank to start unsponsored ADR programs for a greater number of companies.
Sponsored programs for ADRs--negotiable certificates that represent securities of non-U.S. companies--require depositary banks to sign contracts with issuers outlining the services they plan to offer. Unsponsored programs can be established without the issuer's consent, although banks say they tell the companies as a matter of professional courtesy.
Since Oct. 10, when the rule went into effect, the banks have filed registration statements for more than 1,000 unsponsored ADRs, according to industry estimates. Bank of New York Mellon says it has registered more than 500.
American Depositary Receipts have become a common tool for U.S. investors seeking to diversify their holdings while avoiding the costs and administrative burdens of trading and processing foreign equities. About 500 companies list their ADRs on the New York Stock Exchange and Nasdaq Stock Market through sponsored programs; another 800 trade over the counter.
Although the rule change could increase liquidity for unsponsored ADRs, which tend to be thinly traded, it also raises the potential for foreign companies to attract more than 300 U.S. investors, according to Colin Diamond, a partner at law firm White & Case in New York. An issuer that crosses that threshold, explained Diamond, could be forced to register with the SEC if it fails to satisfy the ongoing requirements for the Rule 12g3-2(b) exemption. That would be a heavy burden for a company that may never have taken steps to establish a U.S. trading market, he added.
To avoid becoming subject to full-blown U.S. reporting requirements, a company with over 300 ADR holders must post documents in English on its Web site and monitor transactions to ensure that more than 55 percent of its worldwide volume trades in non-U.S. markets.
"One of the goals of the SEC's amendments was to provide investors in unsponsored ADR programs with easier access to financial information by enabling foreign companies to satisfy the exemption by posting information on their Web sites," said Diamond. "However, the amendments also have the effect of making it easier to establish an unsponsored ADR program, and foreign issuers could face negative perceptions should the unsponsored program fail to attract U.S. investor interest."
Investors, he noted, may not understand that the unsponsored ADRs are not endorsed by the issuer and that service levels will differ among depositary banks. The SEC does not allow a company to start a sponsored ADR program if an unsponsored one exists. To do so, issuers must pay one or more banks to cancel existing programs and transfer the ADR holders.
Complicating matters for foreign companies is that only issuers of sponsored ADRs that are exchange-listed know who their underlying shareholders are--the exchanges require depositary banks to forward proxy materials to investors. Issuers of unsponsored ADRs could find it harder to make a quorum or obtain the required vote if a substantial number of U.S. investors do not receive proxy materials.
