Establishing a US ADR Program for Romanian Listed Companies
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.
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.
Requirements and Practicalities of Establishing a Level 1 ADR Program
US Securities Law Requirements (Rule 12g3-2(b))
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.
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.
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).
Unsponsored Level 1 ADR Facilities
The 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).
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.
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).