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Table of contents:



1. How Do ADRs Work?

2. ADR Advantages for Investor

3. ADR Disadvantages for the Investor

5. Disadvantages for the Issuing Companies

6. Interest of Russian Companies in ADR Facilities


1. Basic Features

2. Registration Requirement

3. Exchange Act Reporting

4. Rule 144(a) and Private Placements


1. General Approach

2. Unsponsored ADR Facility

3. Sponsored ADR Programs

4. ADR Listing Requirements


1. General Characteristics

2. Aurotek-Rogers Test

3. Rule 10b-5






The integration process of the markets began more than twenty years ago and has developed dramatically worlds capital over the past few years. With the increased sophistication of the market players (borrowers, investors and financial intermediaries), rapid advances in information technology and communications, and great co-operation among financial regulators, the international capital markets are now more closely linked than before.

Depository receipts (DRs) are an important element in the market integration process. They allow domestic investors to acquire and trade in foreign securities, while at the same time giving the issuing corporations access to the major stock markets of other countries.

In the last few years, the depository receipts concept has developed considerably. Issuers in a variety of countries have realized that there are a number advantages in making their stock available in a form convenient not only to U.S. investors but also, or alternatively, to investors in the Euromarkets or elsewhere. This has prompted the development of European Depository Receipts (EDRs) 1 and Global Depository Receipts (GDRs) 2.

American Depository Receipts (ADRs) are USA dollar denominated negotiable instruments issued in the U.S. by a depository bank, representing ownership in non-U.S. securities, usually referred to as underlying ordinary shares. ADR can also be used to represent debt securities or preferred stock. ADRs make it possible for a U.S. investor to acquire and trade in non-U.S. securities denominated in U.S. dollars without concern for the differing settlement timetables and the problems typically associated with overseas markets. ADRs also provide foreign companies with the access to the U.S. capital market, the largest and the most efficient investor base in the world.

There are several types of ADR, each of which involves a different level of disclosure of information and compliance with the requirements of the Securities and Exchange Commission (SEC). Depending on the ADR type, the issuer obtains a different types of access to the U.S. investors base. Some ADR structures allow the issuer to raise a capital in the U.S., while others simply provide the company with a possibility to enhance its international image and make it easy for the U.S. investors to buy and trade existing shares of the company.

Historically, it is considered that the first ADR program was developed and introduced by the Guaranty Trust Company in cooperation with several U.S. and foreign arbitrage brokers in response to a law passed in Britain which prohibited British companies from registering shares overseas without a British - located transfer agent 3. UK shares were not allowed physically to leave the UK, and so, to accommodate U.S. investor demand, a U.S. instrument had to be created. This instrument was called an American Depository Receipt. In its present form ADR came to existence in 1955, when the SEC introduced its Form S-12, for registering all depository receipts programs. Form S-12 was later substituted with Form F-6, which is still in operation today.



1. How Do ADRs Work?

If investor is willing to acquire shares in a foreign company, he can either buy the foreign shares in the local market through a broker in that country or, providing the foreign company in question has an ADR program, the investor can request his broker to buy ADRs. The broker may either purchase existing ADRs or, if none are available, he may arrange for a depository bank to issue new ones.

The depository receipt is issued by a U.S. depository bank, when the foreign company shares are deposited in a local custodian bank, usually by a broker who has acquired the shares in the open market. Once issued, ADRs may be freely traded in the U.S. over-the-counter market (OTC), in case of the Level I ADRs, or, upon compliance with U.S. Securities and Exchange Commission regulations, on one of the U.S. national stock exchanges (Level 2 and 3 ADRs). When the ADR holder sells, the depository receipt can either be sold to another U.S. investor or it can be canceled. In the latter case, the ADR certificate would be surrendered to the depository and the shares held by the custodian bank in the country of issuing corporation be released back into the domestic market, most likely sold to a broker there. The depository receipt holder is eligible to request delivery of the actual shares at any time, provided that it is allowed under the laws of the country where the shares have been issued. For example in Peru it is prescribed by local legal requirements that securities must be physically presented at the Lima Stock Exchange in order to finalize a trade.4

Shareholder information such as annual reports, notices of general meetings and corporate actions, and official news releases are provided by the issuer to the depository and the receipt holders, either direct or through the local custodian. The investor is, thus spared the costs and difficulties often encountered when direct investment is made in local markets, where currency, settlement, and linguistic problems may be compounded by an excessive number of intermediaries.

ADR holders are entitled to all the dividends payable on the underlying foreign shares and, furthermore, to have these dividends paid in U.S. dollars.

The demand by American investors for ADR is growing between 30 to 40 percent annually and is driven by the increasing desire of retail and institutional investors to diversify their portfolios globally.5 These investors, as a general rule, do not, or cannot for various reasons which will be explored further, invest outside of the U.S. and, as a result, utilize ADRs as a means to diversify their portfolios. Investors who do have the capabilities to invest outside the U.S., usually investment banks, prefer to utilize ADRs because of the convenience, enhanced liquidity and cost effectiveness ADRs offer, as compared to acquiring and safekeeping ordinary shares in the home country of the issuer.

ADRs are issued when investors decide to acquire securities of a non-U.S. company. To achieve this they contact their brokers to make a purchase. These brokers, through their international offices or through a local broker in the company's home market, purchase the ordinary shares of the target company and order that the shares be delivered to the depository bank's designated custodian in that country. The broker who carries out the transaction will convert the U.S. dollars received from the investor into the corresponding foreign currency and pay the local broker for the shares acquired. Purchased shares may be delivered to the custodian bank at the same day. In its turn the custodian notifies the depository bank on the results of the transaction. Upon such notification, the depository issues ADRs and delivers them to the initiating broker, who then delivers the ADRs to the investor.

As soon as ADRs are issued, in accordance with the SEC requirements, they may be traded in the United States and, just as with any other U.S. security, they can be freely sold to other investors. When an ADR is sold to another U.S. investor and the existing ADR certificate is simply transferred from one ADR holder (seller) to another one (buyer), it is known as an intra-market transaction.

An intra-market transaction is settled in the same manner as any other U.S. security purchase: in U.S. dollars on the third business day after the trade date and typically through the Depository Trust Company (DTC). Intra-market trading accounts for approximately 95% of all ADR trading in the market today.6

When investors want to sell their ADRs, they notify their broker. The broker can either sell the ADRs in the U.S. market through an intra-market transaction or sell the shares outside of the U.S., typically into the home market, through a procedure known as a cross-border transaction. In cross-border transactions, brokers, either through their own international offices or through a local broker in the company's home market, will sell the shares back into the home market. In order to settle the trade, the U.S. broker will surrender the ADRs to the depository bank with instructions to deliver the shares to the buyer in the home market. The depository bank will cancel the ADRs and instruct the custodian to release the underlying shares and deliver them to the local broker who purchased the shares. The broker will arrange for the foreign currency to be converted into U.S. dollars for payment to the ADR holder.

Once ADRs are issued and there is an adequate number of ADRs outstanding in the U.S. market, usually 3% to 6% of the company's shares in Depository Receipt form, a real intra-market trading market may be established. Until this market develops, most ADR purchases result in ADR issuance versus the deposit of shares. When executing an ADR trade, brokers seek to obtain the best price by comparing the ADR price in U.S. dollars to the dollar equivalent price of the actual shares in the home market. Brokers will buy or sell in the market that offers them the best price and they can do so in three ways: (i) by issuing a new ADR, (ii) transferring an existing ADR or (iii) canceling a ADR. For example, if the price of the shares in the domestic market is $20.12 per share, and the ADR is traded for U.S.$20.14, the broker will buy shares and issue ADR until the price of the shares is pulled up to $20.14, at which point the broker starts simply to buy and sell the existing ADRs which are already in the market.

The continuous buying and selling of ADRs in either market keeps the price difference between the local and U.S. markets to a minimum. As a result, about 95% of ADR trading is done in the form of intra-market trading and does not necessarily involve the issuance or cancellation of ADRs.

When a non-U.S. company completes an offering of new shares, part of which will be sold as ADRs in the U.S. stock market, the company will deliver the shares to the depository bank's local custodian at the time of the closing. The depository bank then will issue the corresponding ADRs and deliver them to the ADR purchasers.

2. ADR Advantages for Investor

U.S. investors have become increasingly interested in overseas markets as a result of their higher yields compared to the U.S. equity market over recent years. This interest is reflected in the number of ADR programs, which grew from 600 in 1984 to 1415 by the end of 1994. Total ADR trading volume on U.S. exchanges has also shown dramatic growth, moving from U.S.$ 15.8 billion in 1984 to over U.S.$ 200 billion in 1994.

From the investors standpoint, U.S. investors buy ADRs for the following reasons: convenience, safety, cost, liquidity and compliance with the regulatory requirements.

2.1. Convenience and Safety

From a convenience perspective, ADR, as a vehicle for trading in a foreign securities, avoids complications in the initial purchase of foreign securities caused by the lack of timely bid quotations. Even on the domestic securities market bid prices quoted in various media channels will differ on a given day between New York, Chicago and Los Angeles.7 In the international markets, quotations are significantly more perplexing, due to untimely transmission and the fact that they are published in a variety of forms that render such quotations difficult to understand.8

Direct equity investment in foreign securities may be subject to various foreign transfer restrictions which control their purchase and resale, as well as physical transportation of the stock certificates.9

In addition to these disadvantages, fluctuating exchange rates and high transportation costs increase the expense and delay of obtaining proceeds from the sale of foreign securities. Although efforts have been made to improve clearance and settlement practices across international borders, certain difficulties still remain. Finally, market risk, also called position risk 10 is lower in case of ADR trading.

In June 1989, Federal Reserve Board Chairman Alan Greenspan addressed members of the Senate Banking Subcommittee on the subject of trends in globalized securities market. Greenspan noted that there is a systemic risk 11 in clearance and settlement delays.12 In the U.S.., the maximum clearance and settlement window period is five days.13 Greenspan warned that any float period in excess of five days introduces significant threats to investment in securities.14 Systemic and failed trade risks are substantially lower if the investor acquires ADRs. Because ADRs settle according to U.S. principles and they settle in U.S., the trade fails very rarely. Trade failure, or settlement risk 15 means nondelivery of ADRs on the settlement date. The failed trade rate in the United States for ADRs is less than 0.5%.16 If the investor buys shares directly in the country of the issuer, the failed trade rate is substantially higher.

There is also some inconvenience in bearer form certificates, issued by the foreign corporations as evidence of stock ownership. Bearers of these certificates have no direct contact with the foreign corporation, no information relating directly to corporate activities such as meetings, dividend declarations, merger and takeover quests, and potential reorganizations. In this situation the investor may rely only on trade publications of foreign origin, hoping that he receives them in time and provided that he does not have problems with foreign language and understanding of the investment data format. By contrast, by using the ADR facility the investor promptly accesses the information disseminated by the depository banks and their affiliates. Moreover, ADR registration requires that the depository specify in the registration statement those provisions which relate to voting procedures, dividend distributions, and circulation of notices and proxy solicitations, along with the other information of similar interest to an equity holder.17

ADRs trade and settle like any other U.S. security. There is no difference between buying shares of Glaxo ADRs and buying Microsoft or Lucent technologies securities. It works exactly the same way and investor pays the same commission rates.

As the legal owner of the deposited securities, the depository is also able to facilitate the transfer of shares by ADR holders. The holder of an ADR certificate can transfer the certificate in the United States through endorsement and delivery to the depository, which, in turn, transfers the ownership of the underlying deposited securities by making an entry on the depositorys books. Without this transfer mechanism, a U.S. owner of foreign securities would be required to transfer securities pursuant to the transfer procedures of the foreign jurisdiction where the foreign private issuer is incorporated. In addition, upon surrender of ADR certificates to the depository, the ADR holder may elect either to (in the case of SEC-registered and the most of privately placed ADR issues) sell the deposited shares in the foreign market, in which case, the foreign shares would be released to the designee of the ADR holder for delivery against payment to close the foreign sale, or surrender ADR certificates to the depository, in which case the holder may receive the deposited shares represented by the ADR certificate.18

2.2. Cost Efficiency

On the cost side, in contrast to the direct investing (buying shares on the local market of issuer) there are some cost advantages from the U.S. investor standpoint.

Custodian fees are avoided. In case of direct investing the investor has to appoint a custodian to hold his shares in the country of issue. Custodian fees may vary from ten to forty basis points annually.19

ADRs simplify the collection of dividends. As a general rule dividends on bearer securities are declared through publication in newspapers in the country of the issuer location. The owner of the bearer securities would collect the dividend by presenting the security certificates to a paying agent. Thus, in case of direct investing, a U.S. securities holder has to monitor foreign newspapers and then attempt to collect their dividend through the international mails. Although big corporate issuers have websites on Internet, thus, obviating the problem of keeping their shareholders informed on corporate actions, the problem of cross-border dividend payments still remains. The ADR facility eliminates both problems (i) information transfer and (ii) dividend payment.

Foreign exchange rates on dividends are better on ADR dividends. As a general rule, when the depository bank pays dividends and converts into U.S. dollars large sums of money, it is able to provide a customer with an exchange rate, that is better than is available form a non-depository bank.

The direct investor also may face some obstacles with protection of his investments on international markets, as remedial measures are generally very obscure. ADRs to some extent, resolve this problem for the investor, as one of the purposes of issuers registration is to make him liable for whatever defaults may occur with securities.

2.3. Compliance With Regulatory Requirements

Depository receipts mitigates the obstacles that mutual funds, pension funds and other institutions may have in purchasing and holding securities outside of their local market, due to the legislative and charter limitations on their ability to invest in foreign securities.

2.4. Liquidity

ADR programs open the issuers stock to a wider investor base, and in the case of American market this base may be substantially bigger than the issuers local one. This fact enhances the liquidity of the underlying securities.

3. ADR Disadvantages for the Investor

It would fair to disclose some disadvantages that the potential investor may encounter while investing in ADRs.

An unsponsored ADR holder and a holder of Level I ADRs may face a problem of the ADR liquidity on U.S. market, due to restrictions on transfer of these securities imposed by SEC;

Disclosure of information and reconciliation of financial statement requirements imposed on issuers by SEC for unsponsored ADR programs and Level I ADRs are minimal. Thus, the investor, sometimes is deprived of the possibility to make a correct judgment on his investment. Only big institutional investors, like investment funds, insurance companies and pension funds may be able enough to collect all necessary information on the issuers market, based on which they may take the risk of investing in these ADRs.

Also, the costs associated with establishing an unsponsored ADR facility is born fully by the investor and may be relatively high.

It would be, however, naive to believe that all those advantages the ADR facility provides, compared with direct investments, are free of charge. The depository bank which undertakes to eliminate all the obstacles for the U.S. investor periodically charges the unsponsored ADR holders fees for its services. In case of sponsored ADR facility, however, all expenses associated with maintenance of ADR program are born by the issuing corporation.

Although investing in ADRs is much safer for the U.S. investor, certain risk still remains. U.S. issuance of ADRs creates an image of stability and security which is belied by the reality of foreign exchange risk and political risk inherent in buying any equity issued in a foreign market, especially an emerging market with insufficient regulatory standards and enforcement. Even though obtaining a favorable court decision confirming an ADR holders rights may be relatively easy, the enforcement procedure, which should take place in the country of issuer may be burdensome for the small corporate or individual investor.

4. Why Do Companies Launch ADR Programs?

ADR programs are becoming more attractive to non-U.S. corporations, as the most effective means of entering the important U.S. market. Furthermore, certain types of ADR programs permit capital raising in the U.S., and the amount of new capital raised through ADRs have risen dramatically, from U.S.$ 2.5 billion in 1990 to over U.S.$ 19 billion in 1994. ADR has also taken on increasing importance in cross border mergers and acquisitions. There are several reasons why non-U.S. companies establish ADR programs. Most of the companies establish ADR programs as a away of entering the U.S. market to tap some demand for their securities. They also provide a simple means of diversifying a companys shareholder base. The U.S. investment community, which is especially sophisticated in industries like telecommunications may more highly value the underlying shares or price/earning ratio on foreign firms in this sector.

ADRs may increase the liquidity of the underlying shares of the issuer and, moreover, it may be the reason for the price appreciation of the underlying securities. For example, shares in Russian companies with programs for foreign investors to trade their shares abroad through the ADR, have outperformed the bullish Russian market. Observing this, Russian investors have started active purchasing of the shares of firms, that are likely to launch an American Depository Receipt. Salomon Brothers calculated that shares of companies with ADRs outperformed the Russian market by 37 percent in 1996 and the market itself rose 156 percent (according to the International Finance Corporation).20 Thus, the simple fact that a non-U.S. company establishes an ADR in U.S., enabling U.S. investors to buy its shares, usually pushes the companys stock into a higher price range.

Companies may establish ADR programs as a means of raising a capital in the United States. In many cases, when a big company is making an offering, their home market cannot absorb it. For example, in 1993 YPF an Argentine oil company did a U.S.$ 3 billion global offering that was part of privatization. YPF was able to raise only U.S. 500 million in the Argentine market. The rest of the needed funds was raised in Europe U.S.$500 million and U.S.$2 billion in the United States through the ADR facility.21

Companies may also establish ADR programs for some other reasons. Roche, the Swiss pharmaceutical company established its ADR program to enable 40,000 of its U.S. based employees to invest in the parent company. It also provided the company executives in U.S. with stock options.

Another obvious advantage of ADR is that it increases the issuers visibility and name recognition in the international markets, which may enhance knowledge of its products and ease the path of future capital raising exercises.

5. Disadvantages for the Issuing Companies

An ADR facility is a very expensive method of entering the U.S. market, and it is not a partucularly efficient mode of entry. The issuer can expect that on ADR public offering may cost to him anywhere between U.S.$500,000 to U.S.$1 million in fees to the legal firms and stock market advisers.22 In case of issuance of an ADR for a Russian company, the expenses may be twice or three times as much, due to the complexity of accounting reconciliation and difficulties associated with work of the issuers' legal advisor.

The lead-in time may also be prohibitive. As a general rule, only registration takes at least two months in case of Rule 144(a) offering and six month for public offering. Collection of documents, filling up forms and due diligence investigation may take years. For example, it took several months for the Russian telecommunications giant Rostelecom, which was stating its Level 2 ADR program, to resolve only one issue, whether Rostelecomes small independent registry - which the company was required to enlist, particularly in light of its hopes for a Level -1 ADR program - should be financially liable for shareholder claims of compensation from registry.23

Internet and electronic means of trading represent a serious alternative to an ADR facility. Computer networks of securities exchanges located in major financial centers are gradually replacing national securities exchanges. In an address to the Senate Committee, Chairman Greenspan stated that although the development of electronic systems for the execution of orders and for verification, clearance, and settlement on real time basis has progressed, such systems are extremely expensive.24 Further development of these systems will depend heavily on integration of local financial markets, mutual confidence in regulatory agencies, and reciprocity in enforcement procedures.25

We should not, however, underestimate the current capacity of Internet trading, where all the worlds stock exchanges and big corporate issuers already have their websites and have established electronic facilities for trading in listed securities and supplying investors with all necessary on-line information. Internet trading has already attracted the attention of European Governments which have reported losses associated with the tax collection. Thus, an ADR facility, which is supposed to fill an informative gap between the foreign issuer and American investor may some time in the near future be replaced with Internet trading. In this event, the protection measures established by SEC will become ineffective since the issuer may obtain unrestricted access to the U.S. market.

6. Interest of Russian Companies in ADR Facilities

The Russian market economy emerged only a few years ago. However, from the beginning, it was clear that without integration into the global market Russia would not be able to develop its national economy to a reasonably sophisticated level.

Recognizing the significance of participation in the global market economy, Russian companies initiated their presence in the capital markets of Europe, Asia and U.S.. This was followed by the establishment of ADR programs. More than dozen of major Russian companies now have begun to enter U.S. markets by employing Level I ADR Programs, including: LUKoil, one of the Russian largest oil companies (date of SEC registration: December 27, 1995); Seversky Tube Works, a major producer of pipelines facilities for Russia's oil and gas industry (Feb. 5, 1996); Torgovy Dom GUM, which operates one of the oldest Moscow's department stores (June 7, 1996); Tatneft, a Tatarstan Republic oil company (June 3, 1996); INKOMBANK, the first Russian Bank established ADR program (May 28, 1996); Chernogorneft, another oil company (March 22, 1996 ). Rostelecom, the biggest Russian telecommunication company has become the first Russian company which has established a Level 2 ADR program and started to trade ADRs on the NYSE on February 17, 1998. Other Russian companies in the process of obtaining SEC approval are Menatep Bank, United Energy of Russia, the nationwide electric energy utility, Purneftegas, NIKoil, Norilsk Nickel and Bank Vozrozhdenie.

Because foreign portfolio investment in Russian firms is occasionally restricted, an important characteristic of the ADR programs is that Russian concerns over foreign ownership are addressed when the shares are first reregistered in the name of the depository institution. In fact, ADR programs for Russian companies can only be created with their active support.

While Russian firms have not yet raised large amounts of capital with ADRs, they are gaining important experience and exposure that will allow them to in the future. As already mentioned, several such ADRs are currently trading in the Pink Sheets over the counter in the U.S., and more are in the SEC registration process:

"LUKoil, with 1994 gross revenues of $4.3 billion, offers an ADR representing 4 ordinary shares, started trading at $17.5 and currently (July, 1996) trades in the $37 $47 range.

Seversky Tube Works, with 1994 sales of $279 million, offers an ADR representing 10 ordinary shares, started trading at $4.17 and currently trades in the $19 $23 range.

Chernogorneft, with 1995 sales of $465 million, offers an ADR for one ordinary share, and starting trading at $5.86 and currently trades in the $9 $12 range.

GUM, with 1995 sales of RR 900 billion, offers an ADR representing 2 ordinary shares, and started trading at $32.75; currently trades $39 $44.

Tatneft, with 1995 sales of $2 billion, offers an ADR for one ordinary share, but has not yet come to market.

INKOMBANK, with total assets as of December 31, 1995 of $2.6 billion, will offer one ADR representing 15 ordinary shares, has received SEC approval, but not yet the approval of the Central Bank of Russia." 26

Rostelecom, telecommunications company started trading of Level 2 ADR on NYSE, on February 17. Each ADR represents six underlying shares. Each ADR is reportedly traded for U.S.$ 20.20-20,25. Merrill Lynch is a financial advisor.

After the "original issues," generating additional depository receipts can be done incrementally, in response to U.S. demand, with the process taking about three days (initiating a new ADR program takes considerably longer). Shares traded as ADRs are effectively taken off the local market, and trade in the United States at the same price as homecountry shares.

Most Russian securities traded the United States are Level-1 ADRs. Level I ADR programs are limited to the over-the-counter market (OTC) and can not be used to raise new capital. However, this program has proved to be relatively inexpensive and does not require detailed disclosure of company financial and business data.

Economic reforms and big industrial projects that are carried out in Russia require significant financial resources. One of the ways to obtain the necessary financing is to raise capital through public offerings of stock. Russias emerging capital market, however, is not able currently, to absorb big offerings because of the absence of institutional investors like pension funds and insurance companies, as well as undeveloped securities market regulations, offering/trading facilities and investor protection mechanisms. Because of the numerous frauds that have occurred in the Russian capital market, like activity of financial pyramids, Russian individual investors have lost much of their interest in investment operations. Thus, apart from borrowings, the only way to obtain financing, is to raise capital on international capital markets. The ability of Russian "public" companies to directly raise equity capital in U.S. markets, however, will be severely restricted for years to come given their absence of audited financial statements and an understanding of the "disclosure to the financial markets" regime that we take for granted.



1. Basic Features

All ADRs are classified as securities and, therefore, are subject to the federal regulations and close attention of the SEC. Two federal statutes provide the primary federal regulation of ADR issuance and trading. The first one is the Securities Act (1933)27, regulates public placement of the foreign securities in the United States issued by a foreign private issuer. The second statute, the Exchange Act28, originally adopted in 1934, governs secondary trading in ADRs in U.S. capital markets. Although there are certain differences in regulation of domestic and foreign securities issuers in both statutes, the framework for both categories is essentially the same.

The Securities Act, which is now sixty five years old still remains one of the most important regulatory documents of the securities market. It was passed just after the crash in the 1920s, as a reaction of Congress to the abuses on securities market that took place during the 1920s, which severely harmed investors. After giving the matter a great deal of thought, Congress determined that the best method to regulate the sale of securities in the United States was by means of full disclosure.29 The U.S. system of securities regulation is not aimed at determining the fairness and attractiveness of the securities offered to the general public. Frode Jensen, III, the author of The Attraction of the U.S. Securities Markets to Foreign Issuers and the Alternative Methods of Assessing the U.S. Markets: From a Legal Perspective represents this idea as follows:

It is not, in general, a matter of concern to the SEC whether or not particular stock is a good to buy at U.S. $30 or U.S.$20, or whether a debt security is properly priced. The focus of our securities law is on full disclosure. The theory is that business prospects, management, and the financial condition of a company are fully and properly disclosed in a registration statement and in the accompanying prospectus, then the investor can make up his own mind regarding the appropriateness of the price and fairness of the transaction.30

2. Registration Requirement

The major cornerstone of the federal securities regulation is the registration requirement. Every issue, offer and sale of a security, unless statutory exempt31, is subject to SEC registration.32 That means that all ADRs, being securities separate and apart from the deposited foreign securities they represent, must be registered under the Securities Act before they may be publicly distributed within the United States.

When a foreign private issuer wants to establish an ADR facility in the U.S. market, such issuer generally proceeds in a manner similar to that of U.S. domestic issuer registering securities. For the purposes of the Securities Act, ADRs and the deposited underlying securities are considered separate securities, each subject to the registration with the SEC unless a relevant exemption is available. The foreign private issuer is required to file with the SEC two registration statements: (1) Securities Act Form F-6, to have authority to register the depository receipt33, and (2) Forms F-1, F-2, F-3 or F-4, to register the deposited shares. The requirement to register both depository and deposited shares, however, is not clearly provided in any rule established by the SEC or statute. The requirement stems from an interpretation of the conditions precedent to the use of Form F-6, which provide that this form may be used only if "the deposited securities are offered or sold in transactions registered under the Securities Act or in transactions that would be exempt therefrom if made in the United States...".34

If the U.S. investor purchases the securities of the foreign issuer on a secondary market, the transaction is usually exempted from the registration requirement in accordance with section 4 of the Securities Act.35 Therefore, as long as deposited shares may be purchased in a secondary market transaction without registration, only Form F-6 must be filed to comply with the instructions relating to use of the form. In contrast, when the foreign private issuer makes a public offering of ADRs, both depository receipts and the underlying deposited securities must be registered.

Three conditions precedent to the use of Form F-6 must be satisfied by the registrant. The Securities Act has established them as follows:

(a) The holder of the ADRs is entitled to withdraw the deposited securities at any time subject only to (1) temporary delays caused by closing transfer books of the depository or the issuer of the deposited securities or the deposit of shares in connection with voting at a shareholders' meeting, or the payment of dividends, (2) the payment of fees, taxes, and similar charges, and (3) compliance with any laws or governmental regulations relating to ADRs or to the withdrawal of deposited securities;

(b) The deposited securities are offered or sold in transactions registered under the Securities Act or in transactions that would be exempt therefrom if made in the United States; and

(c) As of the filing date of this registration statement, the issuer of the deposited securities is reporting pursuant to the periodic reporting requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 or the deposited securities are exempt therefrom by Rule 12g3-2(b) ( 240.12g3- 2(b) of this chapter) unless the issuer of the deposited securities concurrently files a registration statement on another form for the deposited securities.36

The withdrawal right condition mentioned above, as a general rule, is met by the terms of the depository agreement or by the terms of the certificate issued to investors to evidence ADR.

The second and third conditions precedent to the use of Form F-6, in the event of public offering, may be satisfied by registering the deposited securities via a second registration, typically Form F-1. If ADRs are traded on a secondary market without public offering the issuer, in order to satisfy the second and third conditions, must qualify for the exemptions provided by the Securities Act. In many situations the foreign private issuers establish the Rule 12g3-2(b) exemption before the ADR arrangement is created.37

2.1. Form F-6. Registration of the Depository Shares

It has been established that Form F-6 is a basic document for the registration of ADRs, which must be filed by the issuer with the SEC. The Form F-6 registration statement basically consists of two parts. Part I provides a list of the information which must be mentioned by the issuer in the prospectus. Certain disclosure is required with regard to the depository obligations, the depository mechanism and the rights of the ADR holder. Part I may also require to describe the effect of the foreign laws and regulations on the ADR holders.

Part II of the Form F-6 provides a list of exhibits which must be filed as a part of the registration statement. The exhibits are the following:

(a) A copy of the Deposit Agreement or Deposit Agreements under which the securities registered hereunder are issued. If the Deposit Agreement is amended during the offering of the Depository Shares, such amendments shall be filed as amendments to the registration statement.

(b) Any other agreement, to which the depository is a party relating to the issuance of the Depository Shares registered hereby or the custody of the deposited securities represented thereby.

(c) Every material contract relating to the deposited securities between the depository and the issuer of the deposited securities in effect at any time within the last three years.

(d) An opinion of counsel as to the legality of the securities being registered, indicating whether they will when sold be legally issued, and entitle the holders thereof to the rights specified therein.

(e) Furnish the name of each dealer known to the registrant or depository who (1) was deposited shares against issuance of ADRs within the past six months, (2) proposes to deposit shares against issuance of ADRs, or (3) assisted or participated in the creation of the plan for the issuance of the ADRs or the selection of the deposited securities. As to each such person indicate the number of securities proposed to be deposited to the extent known. The information furnished pursuant to this item is not to be deemed 'filed' as part of the registration statement...

Part II also provides a list of undertakings to be furnished by the depository:

(a) The depository undertakes to furnish promptly the following information to the Commission semi-annually, beginning on or before six months after the effective date of the registration statement:

(1) The following information in substantially the tabular form indicated: (i) number of depository shares evidenced by receipts issued during period covered by report; (ii) number of depository shares evidenced by receipts retired during period covered by report; (iii) total amount of depository shares evidenced by receipts remaining outstanding at the end of six-month period; (iv) total number of holders of receipts at the end of six-month period.

(2) The name of each dealer known to depository depositing shares against issuance of ADRs during the period covered by the report.

(b) The depository hereby undertakes to make available at the principal office of the depository in the United States, for inspection by holders of the ADRs, any reports and communications received from the issuer of the deposited securities which are both (1) received by the depository as the holder of the deposited securities; and (2) made generally available to the holders of the underlying securities by the issuer.

(c) If the amounts of fees charged are not disclosed in the prospectus, the depository undertakes to prepare a separate document stating the amount of any fee charged and describing the service for which it is charged and to deliver promptly a copy of such fee schedule without charge to anyone upon request. The depository undertakes to notify each registered holder of an ADR thirty days before any change in the fee schedule.38

Form F-6 does not require information about the issuer, other than identity, to be disclosed. However, Form F-6 obligates the issuer of the deposited securities be reporting under the Exchange Act or furnishing to the Commission certain information which is made public in the country of the issuers incorporation. (Reporting obligations of the issuer is discussed further.)

One of the legal issues related to the use of Form F-6 deals with the question of which entity signs the form. This issue arises from the general registration exemption for the securities issued by U.S. banks. As a general rule, the registration must be signed by the issuer. In the case of an unsponsored ADR facility, however, the issuer is not involved in the facility establishing process and, therefore, may not be liable for the ADR issuance. Who must sign the statement then? This issue will be discussed in detail in the section describing an unsponsored ADR facility.

2.2. Registration of the Underlying Securities39

As it was already mentioned above the underlying securities are also subject to the SEC registration under the Securities Act, in the event, the foreign private issuer enters the U.S. market to raise funds through the public offering of the ADRs. A public offering under the U.S. securities laws requires the filing of a registration statement40 which includes the prospectus.41

A prospectus is an integral part of the registration statement. This part solely, without any other information must be delivered to the investor, the offeree or purchaser of the securities to be issued.

The isuuer is not required to deliver a registration statement to the investor, but it must be filed with the SEC in order to effect registration. The registration statement is subject to the close examination of the SEC. Only after it has been confirmed and approved by the SEC, may the issuer initiate trading.

For all foreign private issuers, other than foreign governments, the Securities Act assigns appropriate registration forms: Forms F-1, F-2, F-3 or F-4.42

As a general rule Form F-1 is used for the initial public offerings of ADRs.43 Forms F-2 and F-3 are primarily used by the foreign private issuers that previously have already registered securities under the Securities Act or Exchange Act.44 Forms F-2 and F-3 allow the issuer to effect registration by reference of reports filed under the Exchange Act. Registration of Form F-2, however, requires delivery of the reports filed earlier with the prospectus.45 Additional requirements for the use of Form F-3 are that the foreign private issuer (i) must be reporting for at least thirty-six months46 and (ii) be so-called "world class issuer".47 A "world class issuer" is defined as an issuer, whose voting stock held worldwide by non-affiliates, has an aggregate market value equivalent to U.S. three hundred million dollars or more. The aggregate market value of the stock is computed by use of the last sales price of the stock or the average of the bid and asked prices of the stock in the principal market for such stock within 60 days prior to the date of filing of Form F-3.48

The Form F-3 may be used for (i) certain primary offerings, (ii) offerings of investment grade debt securities, (iii) securities issued in exchange of certain rights and warrants, (iv) securities issued pursuant to a dividend reinvestment plan or conversion of outstanding securities, or (v) securities issued in a secondary offering.49

Form F-4 is used, as a general rule, for various business combinations like reclassifications, mergers, consolidations, transfers of assets and exchange offers.50

Form F-1 is a full-disclosure, long-form registration statement, which requires the highest extent of disclosure in comparison with other registration forms and, therefore, is the most expensive and time-consuming document to prepare.

The main requirements of the Form F-1 are:

Information relating to the terms of the issued securities, the plan of the securities distribution, terms of the offering, plan of the use of the raised funds;

A detailed description of the issuers business. This information is to provide

- a discussion of the general developments of the business during the preceding five years;

- basic products produced and services provided by the issuer, principal markets for these products, methods of product distribution to these markets;

- three years income and cash flow statements, with breakdown by category of activity and by geographical markets. Financial information must be supported by discussion of material differences between relative contributions to operating profit as compared to relative contributions to revenues;

- special data relating to the registrants operations or industry, which may cause a material impact on future financial performance of the issuer. The registrant must furnish information about any material risks unknown to the investors, including dependence on major customers, suppliers, governmental regulation, terms of the material contracts, unusual competitive conditions, anticipated raw material or energy shortages (additional disclosure requirements may be set forth in the special guides adopted by the SEC for the companies of the oil and gas industries, banks and insurance companies). Registrant must furnish additional information about operations which have not given revenues for the three preceding years.

a description of the location and conditions of the registrants assets and production facilities and other materially important physical properties. In the case of enterprise involved in extracting of mineral resources business, material information about production, reserves, locations, developments and the character of the registrants interest must be provided (generally, only proven oil or gas reserves and confirmed or probable other reserves may be disclosed).

selected financial information for each of the five years preceding the registration, including revenues, income, assets and long-term obligations.

a management discussion over the financial conditions of the registrant, material changes in financial conditions and results of operations for each year for which financial statements have been provided (three years), including detailed information about general trends, commitments and other material events regarding to capital resources, liquidity and results of operations.

information about pending legal proceedings, control of the registrant by a parent or other entity and 10 per cent shareholders. Describe the nature of the markets where the registrants securities are traded. Information about exchange control, governmental, legal or charter restrictions and limitations which may affect non-resident holders of the registering securities. Disclose holders obligations and liability with regard to the taxes due in accordance with the laws of the country where the registrant is incorporated. Disclose information about the directors and executive offices of the registrant, aggregate compensation paid them for services in the last year. Options made available to the registrants management in a stock subject to registration. Information about the interest of management, controlling shareholders, certain associated persons in material transactions with the registrant.

a description of the securities to be registered;

registrants balance sheets as of the end of the two most recent fiscal years, confirmed by outside auditor. Audited income statements and changes in financial position for each of the three most recent fiscal years.

Requirements of the U.S. securities laws and the SEC to the form and content of the financial statements provided by the registrant are established by the Regulation S-X. These requirements may be summarized as follows:

(i) the registrant must provide interim unaudited financial statements, if on the effective date of the registration the last audited balance sheet is dated more than six month;

(ii) As a general rule statement must be presented in the currency effective in the registrants country;

(iii) the statements must disclose an informational content in a manner similar to statements which comply with U.S. generally accepted accounting principles (GAAP) and Regulation S-X.

(iv) the statements may be prepared according to U.S. GAAP or, alternatively, the registrant may provide statements prepared in accordance with identified comprehensive body of accounting principles together with a discussion and quantification of all material variations from U.S. GAAP and Regulation S-X, with regard to the accounting principles, practices and methods used in preparing financial statements.

(v) the statements and notes should include various supporting information required by U.S. GAAP and Regulation S-X, such as registrant business segmentation, pension information. The registrant may be excused form presentation of this information in the event of registration of securities are to be offered pro rata to all existing shareholders, pursuant to dividend or interest reinvestment plan or upon conversion of outstanding convertible securities or exercise of outstanding warrants.51

2.2.1. Registration and Financial Statements Preparation

The preparation of the registration statement by a non-U.S. private issuer usually requires a significant commitment of management resources to achieve the result which satisfies all the requirements of the U.S. securities regulations and properly presents the issuer to U.S. investors for commercial and marketing purposes.

There are a number of areas that have caused and continue to cause concern for the foreign issuers. Therefore, it is strongly recommended to the foreign issuer to have assistance of an accountant form which is in expert in U.S. accounting principles and practices. Typically it is one of the big international accounting firms with substantial U.S. practice. It is also essential that the issuer has established a relationship with knowledgeable U.S. legal advisers, specialized in the securities business. The bankers which will establish an ADR facility may play an active role in providing legal and investment advice, as well as necessary assistance in preparation, filing of the required documents.

The issuing company represented by its directors, officers, U.S. agents, underwriters, experts, legal advisors, auditors and accountants involved in preparation of the registration statement may have liabilities under the U.S. securities laws for false or misleading statements in or omissions from the filings. Thus, the importance of careful and accurate preparation of the filing must be clearly understood by all participants of the registration process. Preparation of the filing includes (i) due diligence investigation, usually conducted by the outside legal advisor, (ii) audit of the financial information provided by the accounting firm, (iii) outside experts conclusions. Liability of each person mentioned above will be analyzed in more detail further in the Liability chapter.

2.2.2. Registration Disclosure Requirements

The disclosure requirements for the foreign private issuers under Form F-1 are similar to those for domestic United States issuers. Mark A. Saunders, a partner with Haights, Gardner, Poor & Havens, however, in his article American Depository Receipts: an Introduction to U.S. Capital Markets for Foreign companies52, distinguishes four principal differences:

The content of the financial statements of the foreign private issuers must be substantially similar to that required of domestic registrants. There is no need to prepare them is accordance with the U.S. GAAP, however, they must comply with accounting principles generally accepted in the domicile country, and must be supported with a reconciliation of significant variations from U.S. GAAP in the accounting principles applied. In the event establishing an ADR facility for the underlying shares the reconciliation of the differences in the measurement items (income statement and balance sheet amount) is required only in annual reports of the registrant.

As a general rule a full reconciliation of the financial information provided in the registration statement is required only in very specific cases, depending on the nature of the securities to be offered. On most occasions, however, only revenue information need be separated into categories of activity and geographical markets, unless the total operating profit from each segment substantially differs from their respective contributions to total sales and revenue. In the latter case the registrants disclosure is required.

Compensation of directors and officers need be disclosed only in the aggregate unless, as a matter of policy, the issuer discloses this kind of information to its shareholders or makes it otherwise open to the public.

Information regarding transactions with management must be reflected in the registration statement to the extent the registrant discloses such information to its shareholders or otherwise makes it public.

These notes do not relate to the Canadian issuers, which are allowed to offer their securities in the U.S. on the basis of documentation which is primarily complies with Canadian, rather than U.S. requirements.53 The SEC also has adopted Rule 144(a) under the Securities Act, which provides less strict disclosure standards to the issuers due to the limited number of investors able to enter the Rule 144(a) market (see the discussion further).

There are some areas of the concern which nearly all the foreign issuers face while preparing a registration statement.

The financial statements required in the Securities Act registration statement of a non-U.S. private issuer must either be prepared according to U.S. GAAP or in accordance with an identified comprehensive body of accounting principles together with a discussion and quantification of material variations from U.S. GAAP in the accounting principles applied. All financial statements must be audited by accountants who are considered to be independent under the strict requirements of the SEC.

One of the most burdensome requirements is extensive disclosure of the executives compensation54 and all issuers transactions with officers, directors, and shareholders.55 Although the regulations provide a threshold for disclosure of the transactions, which is U.S.$60.000, it is too low, to benefit most issuers.56

Another area of the issuer concern is business segment disclosure. In contrast to the European disclosure standards the U.S. securities regulations require separate lines of business to be described separately.57 For example, a German company may run several businesses and never disclose the profitability of each of the business segments in the home market or make this information public. In the U.S. it has to do so in order to obtain the SEC approval for the registration. For some big European producers that was an obstacle they could not get over, as this kind of information is considered one of a biggest companys secrets and would be harmful if made available to competitors.

Material contracts is another traditional area of concern for the foreign private issuers.58 If the issuing company is dependent upon one or two suppliers and this dependency is based on the contractual relationship, the issuer will have to disclose the terms and conditions of these contracts to the SEC. Confidential treatment of this information, however, may be requested from the SEC. On some occasions the SEC has granted the confidential treatment to certain issuers information, that otherwise would be disclosed.59

Very often foreign issuers encounter a problem with identifying who the competitors are and what is the competitive balance in the industry.60 Issuers also find it complicated to draft Management Discussion and Analyses (MD&A).61 The SEC views MD&A as a means of providing investors with managements views of the future and the prospects for the company and industry. The SEC also requires disclosure of negative trends in a business which may affect the company, or information which may help the investor to determine whether or not there are negative trends in the industry. This disclosure must be accurately written by the issuer and its counsel.

The risk factors section of the registration statement may also be a difficult undertaking for the issuer. The issuing company must in this section present its view, as to what are the risks in making investments and why the investor may lose money.62

The prospectus, on the other hand, may be viewed not only as a selling document, but also as an insurance policy. This is because as long as it fully discloses all material facts it may not be challenged subsequently by investors on the grounds that it failed to fully disclose material facts about the company, its business and its prospects. Due to the very high level of investor protection in the U.S. and very efficient legal mechanisms it may be more important for the issuer that the prospectus be an insurance policy than it is to be a selling document.

3. Exchange Act Reporting

When a foreign private issuer intends to list ADRs on a national securities exchange or quoted on NASDAQ63, it becomes subject to the periodic reporting requirements under the Exchange Act. Such an issuer will be required to file annual reports in accordance with the SEC Form 20-F64 and to submit other information to the extent this information is required to be prepared pursuant to the home market regulations.

When a foreign private issuer has ADRs traded in the OTC market, it may either comply with the periodic reporting requirements or establish and maintain an exemption provided the Exchange Act.

In 1967 the Congress amended the Securities Exchange Act with the section 240.12g3-2 Exemptions for American Depository, which is known as a rule 12g3-2(b). This amendment provides certain exemptions from the registration requirement under Section 12(g):

(a) Securities of any class issued by any foreign private issuer shall be exempt from section 12(g) of the Act if the class has fewer than 300 holders resident in the United States. This exemption shall continue until the next fiscal year end at which the issuer has a class of equity securities held by 300 or more persons resident in the United States...65

A foreign issuer may be also exempt from registration requirements of the Exchange Act, if on the last day of the previous financial period the value of the foreign issuer assets not exceeded U.S.$5 million and the foreign private issuers securities were not quoted on NASDAQ.66

Another way, authorized by the SEC, for the foreign issuer to avoid the registering requirement under section 12(g) of the Exchange Act is to supply the SEC with certain minimum information required from the issuer by its home regulatory authorities:

(b)(1) Securities of any foreign private issuer shall be exempt from section 12(g) of the Act if the issuer, or a government official or agency of the country of the issuer's domicile or in which it is incorporated or organized:

(i) Shall furnish to the Commission whatever information in each of the following categories the issuer since the beginning of its last fiscal year (A) has made or if required to make public pursuant to the law of the country of its domicile or in which it is incorporated or organized, (B) has filed or is required to file with a stock exchange on which its securities are traded and which was made public by such exchange, or (C) has distributed or is required to distribute to its security holders;

(ii) Shall furnish to the Commission a list identifying the information referred to in paragraph (b)(1)(i) of this section and stating when and by whom it is required to be made public, filed with any such exchange, or distributed to security holders;

(iii) Shall furnish to the Commission, during each subsequent fiscal year, whatever information is made public as described in (A), (B) or (C) of paragraph (b)(1)(i) of this section promptly after such information is made or required to be made public as described therein;

(iv) Shall, promptly after the end of any fiscal year in which any changes occur in the kind of information required to be published..., and

(v) Shall furnish to the Commission in connection with the initial submission the following information to the extent known or which can be obtained without unreasonable effort or expense: the number of holders of each class of equity securities resident in the United States, the amount and percentage of each class of outstanding equity securities held by residents in the United States, the circumstances in which such securities were acquired, and the date and circumstances of the most recent public distribution of securities by the issuer or an affiliate thereof.

(2) The information required to be furnished under paragraphs (b)(1)(i) and (b)(1)(ii) of this section shall be furnished on or before the date on which a registration statement under section 12(g) of the Act would otherwise be required to be filed...

(3) The information required to be furnished under this paragraph (b) is information material to an investment decision such as: the financial condition or results of operations; changes in business; acquisitions or dispositions of assets; issuance, redemption or acquisitions of their securities; changes in management or control; the granting of options or the payment of other remuneration to directors or officers; and transactions with directors, officers or principal security holders.

(4) Only one complete copy of any information or document need be furnished under paragraph (b)(1) of this section... Press releases and all other communications or materials distributed directly to security holders of each class of securities to which the exemption relates shall be in English. English versions or adequate summaries in English may be furnished in lieu of original English translations. No other documents need be furnished unless the issuer has prepared or caused to be prepared, English translations, versions, or summaries of them. If no English translations, versions, or summaries have been prepared, a brief description in English of any such documents shall be furnished...67

Hal S. Scott and Philip A. Wellons, in their text book on International Finance68 mention three reasons which encouraged the Congress to adopt this rule. (1) SEC was


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