Foreign private issuers and federal US securities regulations

Last month in this column, we discussed the offering of American depository receipts (ADRs) in the US by Chinese companies as foreign private issuers. To follow up, this article discusses the contents of periodic reports and the requirements applicable to foreign private issuers’ financial statements, as well as the provisions of the Sarbanes-Oxley Act of 2002 (SOX) applicable to foreign private issuers.

Foreign private issuers

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. Foreign private issuers who sell and/or list securities in the United States become subject to certain reporting requirements of the US federal securities laws and to certain provisions of SOX.

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. This requirement is in addition to the registration statement under the Securities Act of 1933 in connection with a securities offering, which was discussed in this column last month. The issuer must satisfy requirements for initial listing and for continued listing, including various financial and corporate governance requirements. Even if a foreign private issuer does not wish to list in the US, but merely registers securities for an offering (either to raise capital or to complete an acquisition using securities as payment), the foreign private issuer becomes subject to the 1934 act for a period of at least one year, during which it must file periodic reports.

Once a foreign issuer has completed its US offering and/or listing, it must file annual reports on Form 20-F and interim reports on Form 6-K. The information in the Form 20-F is similar to the information in the initial registration statement on Form F-1. A Form 6-K is required to report any information which is not contained in the issuer’s latest Form 20-F on file with the Securities and Exchange Commission (SEC) that the issuer (1) makes or is required to make public in its home country, (2) files or is required to file with a non-US stock exchange on which its securities are traded and which was made public by that exchange or (3) distributes or is required to distribute to the holders of its securities. In the case of (1), (2) or (3), the requirement to file only arises where the information concerned is material to the foreign issuer and its subsidiaries taken as a whole.

New rules for annual reports

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 a 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.

Foreign issuers must present financial statements in their Forms 20-F either in accordance with US generally accepted accounting principles, known as GAAP, or in accordance with International Financial Reporting Standards, known as IFRS. Alternatively, they are required to provide reconciliations of their accounts to US GAAP. There are significant differences between IFRS and US GAAP. From a conceptual standpoint, US GAAP is more rule-based, whereas IFRS is principles-based. Specific accounting differences include the following:

1. IFRS does not permit “last in first out” as an inventory costing method;
2. IFRS uses a single-step method for impairment write-downs rather than the two-step method used in US GAAP, making write-downs more likely;
3. IFRS has a different probability threshold and measurement objective for contingencies;
4. IFRS does not recognize curing debt violations after year-end; and
5. IFRS guidance regarding revenue recognition is less comprehensive than the equivalent guidance under GAAP, and contains relatively little industry-specific instruction.

Currently, if a foreign issuer does not present its financial statements either in accordance with US GAAP or IFRS, it is permitted to provide a limited reconciliation to US GAAP in accordance with item 17 of Form 20-F in its annual reports. FIRE will eliminate this concession, and will require foreign private issuers not presenting financial statements in accordance with either US GAAP or IFRS to provide complete US GAAP reconciliations in accordance with item 18 of Form 20-F, beginning with fiscal years ending on or after 15 December 2011.

SOX requirements

Most provisions of SOX are applicable to foreign issuers once they register their securities under the Securities Act of 1933 and list their securities on a US exchange. Because of the globalization of the capital markets, SOX draws few distinctions between domestic and foreign issuers. While a full discussion of SOX is beyond the scope of this article, some key requirements that will be applicable are: CEO and CFO certification of Forms 20-F, management evaluation and reporting with respect to internal controls over financial reporting (first-time issuers are exempt until their second Form 20-F), disclosure controls and procedures, audit committee independence and required functions, financial officers’ code of ethics, and a prohibition on loans to directors and executive officers.

Businesses considering offering securities in the US 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.