HUNDREDS of foreign companies have suddenly found themselves with new securities in the United States as depositary banks have rushed in the past two weeks to register unsponsored American Depositary Receipts (ADRs) on their shares — in most cases without their consent.
Under relaxed new rules that went into effect on October 10 (PDF 1.5MB, 74 pages), US ADR banks can register unsponsored ADRs on the equity securities of any non-US company that automatically qualifies for an exemption from US registration by meeting certain ongoing trading and web disclosure requirements. In some cases, companies may not be aware that they can use the exemption or even that it exists.
|A sample of the more than 500 ADR filings made to the SEC in the past two weeks.|
The hundreds of new unsponsored ADRs trade in the US over-the-counter (OTC) market, which historically has had a low profile among US investors. However, that could change due to a separate new rule designed to improve trading liquidity and price transparency of foreign company ADRs.
Depositary banks are not required to obtain permission or even notify the companies before registering unsponsored ADRs with the US Securities and Exchange Commission (SEC). The SEC decided not to make the banks notify companies even though it was urged to do so by EuropeanIssuers, a group representing 9,000 European companies.
The depositary banks’ actions raise a number of important regulatory and investor relations issues for non-US companies that find themselves with a new unsponsored ADR program in the US through no action of their own.
According to attorney Rich Kosnik, head of the New York Office securities practice at law firm Jones Day, by creating the unsponsored ADR programs, the banks are increasing the chances that the foreign companies will attract more than 300 US investors. This is the threshold at which non-US companies are required to register their shares with the SEC and comply with its rigorous requirements, including those under the Sarbanes Oxley legislation.
The risk that companies will exceed the US investor threshold is further complicated by a separate rule by the Financial Industry Regulatory Authority (FINRA) that went into effect on Monday. It requires real-time dissemination of trade information in foreign OTC securities, including unsponsored ADRs.
While it is still too early to tell, this change could potentially lead to increased liquidity for these historically thinly-traded securities since it qualifies them to be included in indexes and the portfolios of more institutional investors. Retail investors could also be attracted to OTC ADRs of non-US companies due to the new trading transparency.
However, even if a non-US company exceeds the 300 US investor limit, it can still be exempt under the SEC’s revised Rule 12g3-2(b). This automatically exempts foreign companies from having to register their securities if they meet specific requirements, including that they promptly post their home country disclosure documents in English on their websites and that no more than 45% of their worldwide trading volume occurs in the US.
Companies do not have to apply to the SEC for this exemption as they did in the past, so many may not be aware that it exists or that they qualify.
Loss of control
The self-executing Rule 12g3-2(b) is the same provision that US depositary banks are using to create unsponsored ADRs on foreign companies’ stock. They are using a simple checklist and visiting companies’ websites to see if they qualify for the exemption before registering ADRs with the SEC.
Consequently, the US banks are indirectly imposing an obligation on the affected non-US companies to continue promptly posting English disclosures on their websites or a public online regulatory repository as insurance against having to register their securities with the SEC if they attract more than 300 US investors.
This is most likely to be a burden on companies whose disclosure documents have to be translated. In some cases, the SEC requires English documents to be posted on the same day as the non-English ones.
Compounding the challenges for non-US companies with unsponsored ADRs is that they have no control over the securities, which could potentially amount to a sizeable portion of their shareholder base. And since ADR banks typically only provide ownership information to companies that contract with them to provide a sponsored ADR program, the non-US firms will have difficulty determining how many US shareholders they have.
Furthermore, the SEC will not permit a company to establish a sponsored ADR if an unsponsored one already exists. To establish a sponsored ADR, the company and its depositary may have to pay fees to one or more other banks to cancel an existing unsponsored ADR. In some cases, several depositary banks have registered unsponsored ADRs on the same company’s stock. For example, three depositaries have registered unsponsored ADRs on Suzuki Motor Corp.
More than 500 filings made
Since the new rules went to effect on October 10, US depositary banks have filed to register more than 500 new unsponsored ADRs. The subject companies are located in a wide range of countries, including Japan, Australia, New Zealand, China, South Africa, Germany, Denmark, Finland, the UK and Brazil.
The Bank of New York Mellon and Deutsche Bank Trust have been most active in registering new ADRs, although Citibank has been following suit in recent days. Yesterday, BNY Mellon acknowledged that it had registered more than 200 unsponsored ADRs.
It is unclear how many foreign companies are even aware of the depositary banks’ actions. My inquiries to several companies have gone unanswered.
When I asked BNY Mellon Vice President Jason Paltrowitz last week if the bank had obtained permission from companies before establishing the unsponsored ADRs on their stock, he said they had “notified most issuers of the rule change and the eventual creation of unsponsored DRs.”
In other words, they did not get permission, even though part of the SEC’s reason for not imposing a requirement on the banks was because Deutsche Bank Trust told the commission in a letter dated April 21, 2008 (PDF 2.7MB, 5 pages) that banks typically obtain the issuer’s consent before establishing an unsponsored ADR facility, so a rule requiring such consent was not necessary.
Looking at the websites of some of the companies that have been targeted by the ADR banks, it’s clear that they have no interest in using their websites to communicate with US investors. The website of Investor AB in Sweden, for instance, includes a prominent disclaimer at the bottom of each page stating: “This website is not intended to offer or to promote the offer or sale of Investor AB securities in the United States or to U. S. persons.”
Another example is the UK’s 3i Group plc, which requires visitors to acknowledge that they are not US residents or have the company’s permission before they can access its website. Despite this, BNY Mellon on October 15 registered an unsponsored ADR on the company’s shares.
How will SEC enforce web requirements?
How the SEC will treat companies that take no steps to voluntarily create a market for their stock in the US and yet inadvertently fail to meet its regulatory requirements is unclear. When I asked the SEC if they would be actively monitoring companies websites for compliance, SEC spokesman John Heine declined to comment.
Although the SEC and FINRA rule changes raise concerns for many unsponsored ADR issuers, they also offer other companies a cheaper and potentially more effective way to maintain the exemption from SEC registration. The real-time trade information could also help to improve liquidity of sponsored ADRs that trade in the OTC markets.
In the next issue of our paid publication, Online IR Trends Quarterly, we provide detailed recommendations and practice examples for companies that have OTC-traded ADRs.