Introduction |
Through a so-called “sponsored Level 1 ADR program,” listed companies in
Romania and from around the world can make their shares available to US
investors on the over-the-counter market in the form of depositary
receipts. To date, few Romanian listed companies have taken advantage of
the new possibilities in the US equity markets, possibly as a result of
unfamiliarity with the new regulatory regime. This article provides
Romanian entrepreneurs with an summary of what they need to know in
order to capitalize on the opportunity to raise equity capital in the US
markets through this new regulatory regime. |
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Overview |
Sponsored depositary receipts (called “ADRs”, or American Depositary
Receipts) are securities issued by a US depository bank that has been
contracted by the company for such purpose. The ADRs represent the
common stock of the Romanian (or any other non-US) listed company. A
“Level 1” ADR program, as distinguished from a Level 2 or Level 3
program, does not require compliance with numerous requirements of the
US Securities and Exchange Commission (the “SEC”). Thus,
- no filings are required to be made with the SEC;
- the issuer is not required to provide US GAAP or reconciled
financial statements; and
- the issuer is not required to comply with the Sarbanes-Oxley
Act, which has increased the regulatory compliance burden for
US-listed companies.
The main drawback of a Level 1 ADR program, compared to the Level 2 or Level 3
programs, is that the ADRs are traded over-the-counter rather than being listed
on a stock exchange in the United States, and therefore trading volumes and
liquidity in the US are likely to be lower.
Establishing a sponsored Level 1 ADR program can be a cost-effective means of
introducing a company to the US equity market, and can pave the way for a US
listing at a later date. It also can be a way to provide equity based
compensation plans for US employees, who will gain a potential domestic resale
market for the equity interests they receive. Furthermore, establishing a
sponsored ADR program can eliminate a problematic unsponsored ADR program that
may have been established by a depositary bank without the company’s consent, as
further described below. |
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Requirements and Practicalities of
Establishing a Level 1 ADR Program |
As a result of a rule change in 2008, the requirements for establishing
the program have become fairly straightforward:
• the issuer must not be subject to the US Securities Exchange Act (this
generally means the company is not required to file periodic reports
with the SEC);
• the issuer must maintain at least one non-US stock exchange listing;
• the issuer’s Romanian or other non-US exchange listing must be its
“primary trading market” (55% trading volume in primary trading market).
Companies may calculate this figure by aggregating trading on two non-US
exchanges, subject to certain limitations;
• the issuer must publish in English (on its website or through an
electronic information delivery system) material information that it:
- makes public or is required to make public
pursuant to Romanian or other home country laws;
- files or is required to file with its stock
exchange; and
- distributes or is required to distribute to its
security holders;
• at a minimum, the issuer must electronically publish English
translations (not versions) of annual and interim reports (with
financial statements), press releases and documents or communications
sent directly to shareholders; and
• the issuer must also be a “foreign private issuer” meaning generally
that it is a company organized under the laws of a jurisdiction outside
the United States, with most of its assets, business and management
located outside the United States and no more than 50% of its
outstanding voting securities held by US residents.
As a result of the recent rule changes, companies seeking to establish a
Level 1 ADR program are no longer required to make a submission to the
SEC seeking approval, nor are they required to indicate in such
application how their current US shareholders came to own shares or
depositary receipts. As a result of these regulatory changes, numerous
Level 1 ADR facilities have been established since October 2008. |
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Establishing the Program |
A
sponsored ADR program is established by engaging a depositary bank in
the US that issues depositary receipts tied to the issuer’s shares that
are then tradable in the United States. Many large commercial banks
provide depositary services, such as Bank of New York Mellon, Citi,
Deutsche Bank and others.
The following are some of the main characteristics of ADRs:
• they are negotiable instruments issued by a US depositary bank
evidencing ownership of shares in a non-US corporation;
• each ADR denotes a specific number of underlying shares on deposit
with a custodian in Romania or another home market of the issuer (the
custodian is a bank engaged by the depositary bank that is often an
affiliate bank of the depositary bank);
• the ratio of ADRs to underlying shares is usually set to cause ADR
pricing to be in the normal stock price range seen in US markets (e.g.,
$17-$35 per share); and
• ADRs are governed by a depositary agreement between the issuer and the
US depositary bank, which is a New York law-governed contract.
Filing a Form F-6 with the SEC
Although disclosure about the issuer’s business is no longer required to
be filed with the SEC, the US depositary bank (not the company) is
required to file a simple registration statement with the SEC called a
Form F-6. The Form F-6 is publicly available on the SEC’s website (www.sec.gov).
Information required to be included in the Form F-6, either as
disclosure or an exhibit, includes:
- the identity of the issuer and the depositary bank;
- a brief description of the ADRs;
- an opinion of counsel as to the legality of the ADRs; and
- a copy of the deposit agreement governing the rights of ADR
holders.
Levels of ADR programs compared
As mentioned above, there are three levels of ADR programs.
Level 1 ADR programs involve ADRs that
- trade solely in the over-the-counter market
- are not listed on any US stock exchange, such as
the NYSE or NASDAQ, and
- do not involve any SEC reporting by the issuer.
In contrast, Level 2 ADR programs involve ADRs that
• are listed on a US stock exchange, and
• for which periodic reports are filed with the SEC.
Level 3 ADR programs involve
• exchange-listed ADRs that are issued to investors in a capital raising
transaction (effectively the US initial public offering of the non-US
company), and
• more burdensome regulatory requirements than for a Level 2 ADR
program, in that a registration statement must be filed and declared
effective by the SEC prior to the offer and sale of new securities to
investors.
Issuers with Level 2 and Level 3 ADR programs are subject to full SEC
reporting, including financial statement and Sarbanes-Oxley
requirements. |
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Establishing Over-the-Counter Trading |
In
a Level 1 ADR program, the depositary receipts become quoted on the US
over-the-counter (OTC) market, a network of securities dealers that make
markets in different securities. All Level 1 ADRs are traded in the OTC
market via the so-called “Pink Sheets,” presently operated by a company
called Pink Sheets LLC (see
www.pinksheets.com). This is a privately owned New York-based
company that provides an Internet-based, real-time quotation service for
OTC equities and certain other securities. Quotation on the Pink Sheets,
unlike the OTC Bulletin Board, which is a more sophisticated quotation
system for OTC securities, does not require an issuer to file regular
periodic reports with the SEC.
Quotation on the Pink Sheets simply requires a broker-dealer to act as a
market maker and quote a price for the ADRs. Only SEC-registered
broker-dealers that are members of the U.S. Financial Industry
Regulatory Authority (FINRA) can quote securities prices in the Pink
Sheet system. There are over 200 registered broker-dealers that make
markets in OTC shares. An issuer’s US law firm, as well as the
depositary bank, can provide assistance in choosing a market maker. Once
the ADR program is established, additional broker-dealers may also act
as market makers, with or without the issuer’s permission.
A broker-dealer that provides price quotations for ADRs that are traded
over-the-counter is required to have obtained and reviewed (and provide
to investors upon request) all information that the issuer has
electronically published, usually on its website, in compliance with SEC
Rule 12g3-2(b). |
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Unsponsored Level 1 ADR Facilities |
TThe SEC’s October 2008 rule changes for the first time permit
depositary banks to set up Level 1 ADR programs without the consent
of issuers, provided such depositary bank has a reasonable good
faith belief, after exercising due diligence, that the issuer complies
with Rule 12g3-2(b). As a result, hundreds of unsponsored ADR programs
have been set up in the US since October 2008 by depositary banks
seeking to collect the fees associated with ADR trading.
Unsponsored ADR programs can be problematic for issuers in that:
- the ratio of ADRs to shares may not be
optimally set;
- multiple programs may confuse investors
with varying prices, certificate-to-underlying-share ratios, fees,
services and exchange rates for dividend payments; amd
- The issuer might be unable to satisfy quorum and voting
requirements at stockholder meetings, because depositary banks
usually do not give ADR investors voting rights or send them reports
to shareholders unless they have been specifically engaged by the
issuer to do so and the corporation law of the issuer’s home
jurisdiction permits it (see next section).
A common way of discouraging unsponsored programs is to establish a
sponsored program, which usually has the effect of driving investors
toward the sponsored ADRs. If this approach is taken, the SEC also
requires the sponsored depositary and the issuer to represent in the
Form F-6 that arrangements are in place to terminate any existing
unsponsored ADR programs in a prompt and orderly fashion. Written
confirmation from the depositaries of the unsponsored programs as to
their concurrence with such arrangements also may be required. The
company or its attorneys are responsible for obtaining such concurrence.
If an issuer has no plans for creating a sponsored program, it may
combat the establishment of unsponsored ADR programs by issuing
statements denying that it has electronically published all necessary
English language information, or otherwise has not complied with Rule
12g3-2(b). |
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Voting Rights of ADR Holders |
Some sponsored programs allow holders of ADRs to vote their ADRs through
the depositary in cases where the issuer seeks a shareholder vote.
Whether voting is available depends largely on the corporate law of the
issuer’s home jurisdiction, and whether a record owner (the depositary
or its custodian) or the beneficial owner (the ADR holder) can vote. As
far as Romanian listed companies are concerned, only the custodian, as
the holder of record, is entitled to vote. However, there are no legal
restrictions against the custodian following the voting instructions of
a majority of ADR holders pursuant to the depositary agreement, a
private contract. Typically, in a sponsored Level 1 ADR program, the
depositary agreement requires the depositary to forward shareholder
meeting information to holders of ADRs. Thus, in effect, ADR holders can
participate in shareholder voting for Romanian companies. |
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Liability to US Holders for Misstatements
and Omissions |
Some
US statutes and rules that provide liability for misstatements and
omissions of material fact do not apply in the context of a Level 1 ADR
program, most notably Section 11 of the Securities Act, which applies
only to registered securities offerings. The most important applicable
anti-fraud provision under the US securities laws is Rule 10b-5 under
the Exchange Act, which imposes liability on issuers and control persons
for misstatements or omissions in disclosure documents, regardless of
whether such documents were filed with the SEC. Liability under Rule
10b-5 requires at least some degree of “scienter,” however, which
generally means having intent to deceive, manipulate or defraud, or at
the very least a reckless disregard for the truth.
Despite this rather difficult standard of proof, the issuer will need to
be mindful of this potential risk and take due care in the preparation
of its public statements for its home markets, which are then
electronically published for US investors pursuant to the information
requirements of Rule 12g3-2(b). |
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Editors Note: It is our policy not to mention our clients by name in
The Romanian Digest™ or discuss their business unless it is a matter of
public record and our clients approve. The information herein is correct
to the best of our knowledge and belief at press time. Specific advice
should be sought from us, however, before investment or other decisions
are made.
Copyright 2010 Rubin Meyer Doru & Trandafir, societate civila de avocati.
All rights reserved. No part of The Romanian Digest™ may be reproduced,
reused or redistributed in any form without prior written permission
from the publisher.
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