ADRs: access to the US capital markets for foreign private issuers

By Julie Allen, Proskauer Rose
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Chinese companies wishing to raise capital and list their securities in the US as foreign private issuers may offer either their ordinary shares or American Depository Shares (ADSs) evidenced by American Depository Receipts (ADRs). An ADR is a negotiable certificate that represents ADSs, which in turn represent the underlying foreign shares. ADSs are typically issued by a US bank, called the depository. The depository, in turn, has a foreign correspondent, called the custodian, with which the underlying foreign shares have been deposited. ADRs are the form in which the overwhelming majority of foreign issuers offer and list their securities in the United States.

Julie Allen, co-chair of the capital markets practice group, Proskauer Rose
Julie Allen
Co-chair of the capital markets practice group
Proskauer Rose

Under US securities laws, a “foreign private issuer” is defined as a non-US issuer (other than a foreign government) the majority of whose stockholders, directors and officers are non-US persons, the majority of whose assets are located outside the US and whose business is administered principally outside the United States.

ADRs offer several benefits to foreign issuers and their US investors. First, ADRs avoid the difficulties often encountered in transferring shares between US and non-US clearing systems. ADRs are transferred just like a domestic US stock certificate, without regard to foreign transfer procedures. Second, since each ADR may represent one or more ADSs (or even a fraction of an ADS), ADRs facilitate compliance with minimum price listing requirements and market expectations regarding the price of an offered security if the US dollar equivalent of the market value of the underlying shares would be unusually high or low. An ancillary benefit when ADRs represent multiple underlying ADSs is that listing fees, which are typically based on the number of securities listed, are lower. Third, ADRs avoid problems US investors may encounter with foreign securities that may be available only in bearer form. These include difficulties in receiving information about dividends (announced only in foreign newspapers) and difficulties in establishing compliance with listing standards regarding the minimum number of holders. Fourth, dividends are collected by the depository, converted from local currency into US dollars and paid to the US investors.

There are three levels of ADR programme. A Level 1 programme permits trading in the US over-the-counter market of the securities of a foreign issuer whose securities are traded on a foreign stock exchange. A Level 2 programme involves listing on a US exchange without raising capital in the US. A Level 3 programme involves both a public offering in the United States to raise capital and a listing on a US exchange.

Where an issuer conducts a public offering in the United States through a Level 3 ADR programme, the issuer is technically offering two securities – the underlying shares and the ADSs – both of which must be registered pursuant to the Securities Act of 1933. For first-time foreign issuers, the underlying shares are registered on a Form F-1 and the ADSs are registered on a Form F-6. The Form F-1 registration statement includes the disclosure document made available to prospective investors, called a prospectus, while the F-6 consists of little more than the deposit agreement.

The issuer must disclose information in accordance with detailed Securities and Exchange Commission (SEC) regulations, including information regarding the issuer’s business, its management and board of directors and the securities being offered. In addition, the issuer’s financial statements and related disclosures regarding its financial condition and results of operations must be included. For first-time issuers, the process of preparing the Form F-1 can be time-consuming. The issuer, its counsel, the underwriters and their counsel and the issuer’s accountants are all involved in the drafting process, which typically takes between four to eight weeks.

Procedures and requirements

Almost all registration statements filed by first-time issuers receive a full review by the staff of the SEC. The focus of the SEC review is on compliance with the federal securities law disclosure requirements, not the merits of the offering or the issuer’s business. As a matter of policy, the SEC will accept draft registration statements from non-US issuers for review on a confidential basis if the non-US issuer is entering the registration and reporting system for the first time. This informal process is available for both initial public offerings and for first-time exchange listings not accompanied by a securities offering.

Before an issuer can list securities on a US securities exchange, including securities represented by ADRs, the securities must be registered under Section 12 of the Securities and Exchange Act of 1934, which is in addition to the registration statement discussed above under the 1933 Act. In connection with a US exchange listing, the issuer must satisfy requirements for initial listing and for continued listing, including various financial and corporate governance requirements.

Once a foreign issuer has completed its US offering and listing, it must file annual reports on Form 20-F and interim reports on Form 6-K. During 2008 the SEC implemented several rule changes that will affect both the timing and the content of Form 20-F annual reports. Among these changes is the set of rules known as the Foreign Issuer Reporting Enhancements, commonly called FIRE, which became effective on 6 December 2008. Currently, foreign issuers are required to file their annual reports with the SEC and each US stock exchange on which the issuer’s securities are listed within six months after their fiscal year-end. FIRE will accelerate the annual report filing deadline to four months after a foreign issuer’s fiscal year-end, beginning with fiscal years ending on or after 15 December 2011.

The contents of periodic reports and the requirements applicable to foreign issuers’ financial statements, as well as the provisions of the Sarbanes-Oxley Act of 2002 applicable to foreign private issuers, will be discussed in a subsequent article.

ADR offerings permit foreign issuers access to the US capital markets. Businesses considering this alternative should coordinate closely with experienced US capital markets counsel to ensure compliance with the myriad applicable US securities laws.

Julie Allen is the co-chair of the capital markets practice group of Proskauer Rose. Her practice focuses on capital markets and public company representation, including M&A.

Proskauer Rose

1585 Broadway
New York, NY 10036-8299, USA
Postal code: 10036-8299
Tel: +1 212 9693000
Fax: +1 212 9692900
Email: jallen@proskauer.com
www.proskauer.com

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