American Depositary Receipt programs (or ADR programs) frequently make a non-US company's common shares a more appealing investment for US investors. Such programs create a new security (the ADR) that trades and settles in US dollars in the United States, in accordance with US market practice. In addition, the ADR program's depositary will typically convert all dividend payments into dollars before disbursing them to investors. As a consequence, for certain institutional investors, ADRs are deemed to be US domestic securities and therefore are subject to fewer restrictions under internal investment guidelines. For similar reasons, ADRs may also attract US retail investor interest.
A Level 1 ADR program is the easiest and least expensive way for a non-US issuer to establish an ADR program. This briefing addresses a number of the commonly-asked questions relating to the establishment of a Level 1 ADR program in the United States.
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What is an ADR?
ADRs are negotiable receipts issued by a US bank or trust company, as depositary (the Depositary), representing beneficial ownership of common shares in a non-US company. To establish an ADR program a company enters into a deposit agreement (the Deposit Agreement) with the Depositary, which sets forth the rights and obligations of the company, the Depositary and the holders from time to time of ADRs. Under the Deposit Agreement, the Depositary agrees to undertake various tasks, including: (a) accepting shares deposited with the custodian (frequently a branch of the Depositary) in the company's home country and issuing ADRs in respect thereof; (b) registering transfers of ADRs; (c) converting dividend payments into US dollars and distribute them to ADR holders; and (d) mailing such holders English versions of shareholder reports and proxy materials.
The unit in which US ADR-hoIders own the deposited share is called an American Depositary Share (ADS), which is evidenced by the ADR. The number of underlying shares for each ADS is set forth in the Deposit Agreement and normally depends on the recommendation of the company's advisers as to the appropriate trading price for the ADR in the United States.
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What is meant by level 1 ADR program?
There are three types of public or "unrestricted" ADR programs:
Level 1 ADR programs, which trade in the traditional US over-the-counter market and are not listed on any US securities exchange such as the New York Stock Exchange or NASDAQ;
Level 2 ADR programs, which are listed on a US securities exchange (such as the New York Stock Exchange or NASDAQ); and
LeveI 3 ADR programs, in which the issuer uses a listed ADR program to offer new shares to US investors in a capital raising exercise.
In addition, a "restricted" or "Rule 144A ADR" program can be established for ADRs that are privately placed in the United States. In general terms, ADRs in a restricted program trade only among certain large institutional investors know as "Qualified Institutional Buyers" or "QIBs" as defined in Rule 144A under the US Securities Act of 1933 (the Securities Act).
Because a Level 1 ADR program does not require satisfying the listing criteria of a US securities exchange or the registration of the company's common shares under the US Securities Exchange Act of 1934 (the Exchange Act), it is particularly appealing to non-US companies not yet prepared to undertake an initial public offering (IPO) in the United States but who are interested in introducing themselves to US investors.
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How do Level 1 ADRs trade?
As noted above, Level 1 ADRs trade in the US over-the-counter market and are not listed on a securities exchange. The US over-the-counter market consists of a large network of broker-dealers that hold securities in inventory and buy and sell them either for their own accounts or for the accounts of customers. Trades take place over the telephone or, in some cases, by computer, and there are usually several dealers making a market in a given security at any one time. Brokers wishing to trade in Level 1 ADRs access information through the National Quotation Bureau's "pink sheets", the wholesale price quotes for over-the-counter stocks listed by dealers acting as market makers for the individual securities.
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What are the US securities laws registration requirements?
Exemption from registration under the Exchange Act
A non-US company establishing an ADR program that is listed on a US securities exchange generally will be required to register with the US Securities and Exchange Commission (SEC) under Section 12(b) of the Exchange Act and become subject to on-going US reporting requirements and laws such as the Sarbanes-Oxley Act. Consequently, Level 2 and Level 3 ADR programs (which are listed on US securities exchanges) must be registered under the Exchange Act. However, because Level 1 ADRs are not listed on a US exchange, they are not required to be registered under Section 12(b) of the Exchange Act.
Nor are Level 1 ADRs required to be registered under Section 12(g) of the Exchange Act so long as the requirements of the Rule 12g3-2(b) exemption are met. In order to be eligible for the Rule 12g3-2b exemption, a non-US issuer (i) must not otherwise have any reporting obligations under Section 13(a) or 15(d) of the Exchange Act; (ii) must currently maintain a listing of its equity securities on one or more exchanges in a foreign jurisdiction that, either singly or together with trading of that class of securities in another foreign jurisdiction, constitutes the primary trading market for those securities; and (iii) must otherwise have published in English, on its Internet Web site or through an electronic information delivery system generally available to the public in its primary trading market, certain specified disclosure documents it is required to make public under applicable non-US laws (e.g., annual and interim reports, proxy materials, certain press releases and public domestic stock exchange filings). For the purposes of the rule, “primary trading market” is defined as at least 55 percent of the worldwide trading in the subject class of securities took place in, on or through the facilities of a securities market or markets in no more than two foreign jurisdictions during the issuer’s most recently completed fiscal year.
Registration under the Securities Act
Although the company’s ADRs in a Level 1 program are exempted from Exchange Act registration pursuant to Rule 12g3-2(b), the Depositary and the company still must register the ADRs under the Securities Act. However, unlike when a company is preparing a Level 2 or Level 3 ADR program, which involves the preparation of a very detailed US prospectus (or similar disclosure document), the registration statement for a Level 1 ADR (so-called Form F-6) is a very brief document which largely consists of the Deposit Agreement and ADR certificate.
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What are the state securities laws requirements?
Neither the Securities Act nor the Exchange Act entirely pre-empts regulation of the offering or trading of securities by the various US states. Each state has its own statutes for securities regulation, commonly known as "Blue Sky" laws, and many states have adopted, in more or less the same form, the Uniform Securities Act. Therefore, securities that have not been removed from the jurisdiction of state securities regulators are subject to state securities registration and disclosure requirements. Absent on exemption companies must register securities that are traded in a particular state through the filing of an application to register the securities, the furnishing of copies of documents filed with the SEC and consent to service of legal process in the particular state in respect of actions arising out of the sale of the securities. Securities listed on a national securities exchange or quoted through the NASDAQ National Market System are generally exempted from registration. Some states confer an exemption upon a company's securities on the basis of information being publicly available about the company in standard securities manuals such as those produced by Moody's and Standard & Poor's. Companies establishing a Level 1 ADR program can publish certain financial data in a "recognised" securities manual to provide an adequate source of investment information, thus eliminating the need to individually register their securities in the fiftyUS states.
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How long does it take to establish a Level 1 ADR program?
It typically takes eight to twelve weeks to establish a Level 1 ADR program. However, time frames may vary due to the involvement of the SEC in the process and individual program specifics. An indicative timetable for the establishment of a Level 1 ADR program follows:
|Establish team (select depositary bank, US counsel and local counsel)|| || || || || || || || || |
|Ensure issuer is eligible for Rule 12g3-2(b) exemption|| || || || || || || || || |
|Prepare and negotiate Deposit Agreement and prepare Form F-6 registration statement|| || || || || || || || || |
|Submit Deposit Agreement and Form F-6 to SEC; amend as necessary and receive SEC approval|| || || || || || || || || |
|Complete all requirements for over-the-counter trading and settlement (prepare certificates, request CUSIP number, obtain DTC eligibility)|| || || || || || || || || |
|Trading commences |
Distribute announcements to brokers and investors
Depositary solicits market makers
| || || || || || || || || |
|Place optional tombstone ads|| || || || || || || || || |
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What are the principal US Liability considerations for a company establishing a Level 1 ADR program?
For many non-US companies a major concern in accessing the US capital markets is potential liability and the possibility of class actions by US shareholders. Perhaps the most important anti-fraud provision under the US securities laws in this context is Rule 10b-5 under the Exchange Act. In general terms, that rule imposes liability on issuers (and persons who control them) for misstatements or omissions in disclosure documents generally affecting the market place, regardless of whether such documents were filed with the SEC. Therefore, a company establishing a Level 1 ADR program may become subject to potential disclosure liability under Rule 10b-5 if material misstatements or omissions are made in documents affecting the market for the ADRs, such as in press releases or annual or interim reports. A finding of liability requires that there was some level of “scienter”, which generally means intent to deceive, manipulate or defraud or reckless disregard for the truth, on the part of the issuer. As a consequence, once an issuer has established a Level 1 ADR program, it will need to be mindful of this potential risk and take due care in the preparation of its public statements, which it typically ordinarily would be required to do under the rules of its home jurisdiction in any event.
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How will future non-US offerings by the company be affected by a Level 1 ADR program?
After a non-US company has registered any type of security with the SEC, there is an increased need to consider imposing certain types of restrictions on offerings, sales and deliveries of securities of the issuer sold outside the United States which are designed to prevent resale of such securities into the United States or to US persons (including by means of rights offering). Such restrictions may include transfer restrictions, lock-ups, selling restrictions and legending of securities. Alternatively, a non-US company could decide to register the securities under the Securities Act.
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