An ADR' is a negotiable certificate, usually issued by a United States ("U.S.") bank denominated in shares, certifying that a stated number of securities of a foreign private issuer have been deposited with a U.S. bank or its foreign affiliate or correspondent, and will be so held as long as the ADR remains outstanding. As its name indicates, an ADR is a receipt, and in essence is a substitute trading certificate for foreign securities similar to a warehouse receipt for commodities - the holder can transfer title to the underlying foreign securities by delivery of the ADR. The ADR mechanism was developed in the early part of this century to overcome or mitigate certain legal, technical and practical problems confronting U.S. investors in foreign securities. If the foreign securities trade at lower or higher prices relative to the normal trading prices used in the U.S. markets, the unit of trade in the U.S. will be some multiple or fraction of a unit of the deposited securities as designated on the ADR. That U.S. trading unit is usually designated as "American share" or "American depositary share." The use of a multiple trading unit is most often used in connection with ADRs for securities of Japanese issuers. There are three major benefits usually claimed for the ADR mechanism: ease of transfer, reduction of the problems of bearer certificates, and increased availability of information on the issuer of the foreign securities. The increased transferability stems from the status of the depositary or its nominee as the record or legal owner of the deposited securities and the performance by the depositary, for set fees, of services for the ADR holders. Rather than submission for transfer in a foreign country under time consuming and unfamiliar transfer procedures, transfer of the ownership of the deposited securities is made by transfer of the ADRs on the books of the depositary. Foreign inheritance taxes and probate in foreign courts can be avoided if ADRs, rather than the foreign shares, are held. Problems arising under foreign exchange controls are similarly . mitigated. Frequently, foreign securities are in bearer form so a list of shareholders cannot be maintained. The collection of dividends illustrates how ADRs are used to overcome the inherent difficulties of bearer certificates. Declarations of dividends are announced by publication in a newspaper in the foreign country which probably is in a foreign language. The holder of the bearer share collects the dividend from the paying agent (usually a bank) upon presentation of the share certificate. Obviously, it would be virtually impossible for an individual investor in the U.S. to monitor dividend declarations and collect dividends under this procedure. Moreover, even if the investor could collect the dividend, it would be paid in a foreign currency. Commercial banks in the U.S. usually refuse to exchange small amounts of foreign currency. The use of ADRs can eliminate these problems. A major U.S. bank (the "Depositary Bank") will issue ADRs upon the deposit of the foreign shares and maintain a registry of ADR holders. A foreign branch or correspondent of the depositary bank watches for dividend declarations, collects dividends (the bearer certificates usually are physically held in the foreign country), converts the dividends into U.S. currency, and remits the dividend to the ADR holder. Another major advantage claimed for the ADR mechanism is the increased availability of information on the issuer of the foreign securities and its activities. Some foreign issuers are reluctant to deal or communicate directly with U.S. investors basically because of concerns of liability under the federal securities laws. This includes not only rights offerings and tender bids but even mailing the usual shareholder communications, annual reports, proxy statements, etc. As the record or legal owner, the depositary bank or its foreign nominee will receive such notices. Even if the foreign shares are a bearer form, the depositary banks, because of its foreign relationships, is in a better position to obtain such information. Any such information obtained is made available at the depositary's office, usually in New York City. If the ADR arrangement is a "sponsored" one (see discussion below) the ADR holder will receive most of these communications directly from the foreign issuer or through the depositary. Rights offerings, a prevalent means of raising capital by foreign issuers, unless registered under the Securities Act cannot be extended to U.S. investors. Under the usual ADR arrangement, the depositary banks will sell any such rights in the foreign markets and remit the proceeds to ADR holders. 'Also occasionally referred to as "American Shares," "American Shares Certificates," or "New York Shares." Technically the ADR refers to the certificate evidencing a depositary share that represents a multiple of or fraction of a deposited foreign share. See the definition of the term "depositary share" in Rule 405 under the Securities Act. 193 In short, the ADR has many of the characteristics of a domestic share certificate thereby facilitating the trading in and ownership of foreign securities. ADR holders have substantially the same rights as direct holders of the deposited securities.2 Under the current practice, the depositary banks will establish an ADR mechanism at the request of U.S. brokers and arbitragers active in trading foreign securities. Although the ADR mechanism can be established without the concurrence of the particular foreign issuer involved, it is our understanding that the depositary banks will often at least consult with the foreign issuers and refrain from establishing the mechanism if the foreign issuers object.' The ADR mechanism is either a "sponsored" or "unsponsored" arrangement. In the sponsored arrangement, the foreign issuer will assume the obligation to pay some or all of the depositary's transaction fees and usually will agree to provide directly or indirectly through the bank the various shareholder communications. In the unsponsored arrangement, the foreign issuer assumes no obligations and the depositary's transaction fees are paid directly by the ADR holders; there is no privity between the foreign issuer and the depositary. In the sponsored arrangement, the foreign issuer assumes no obligations and the depositary's transaction fees are paid directly by the ADR holders; there is no privity between the foreign issuer and the depositary. In the sponsored arrangement, the rights, duties and obligations of the ADR holders and the depositary banks are usually set forth in a deposit agreement and summarized on the ADR itself. In the unsponsored arrangement, all these matters are set forth only on the ADR.* II. CURRENT REGULATORY STRUCTURE UNDER THE FEDERAL SECURITIES LAWS A. The Securities Act of 1933 The manner in which the Securities Act applies to the securities representing the ADRs depends on whether there is a "distribution" of the deposited foreign securities that requires registration. The depositary shares or the American depositary shares represented by the ADRs are separate securities distinct from the deposited securities for purposes of the Act. The definition of "security" in Section 2(1) states that the term "security" means any...stock...certificate of deposit for a security. . .or in general any interest or instrument commonly known as a security...or any receipt for. . .any of the foregoing." The definition is sufficiently broad enough to cover the ADR arrangement. It is possible, accordingly, to have a distribution of depositary shares though without a corresponding distribution of the foreign securities. This is the usual situation. For example, a trading market may exist in the U.S. for the outstanding securities of a foreign issuer, transactions in which would be exempt ordinarily under Sections 4(1) and 4(3).' However, the establishment of the ADR mechanism for the same outstanding securities results in the offer or distribution of the American share equivalents. Such offers must be registered absent the availability of 2 statutory exemptions. Form F-6 is usually available to register the depositary shares evidenced by the ADRs. If a foreign issuer wishes to raise capital in the U.S. by a public offering of its equity securities, the procedure resembles that of a public offering by a U.S. issuer. The foreign issuer will arrange for a U.S. bank to set up an ADR mechanism, usually under a "sponsored" arrangement. The U.S. investor participating in the offering receives ADRs. The foreign issuer typically would file two registration statements. One is the Form F-6 to register the depositary shares. The other is to register the deposited foreign shares and is on the form that would be available even if ADRs were not being issued, e.g., Forms F-1, F-2, or F-3.6 On June 20, 1955, the Commission held a one day conference on ADRs. This conference was prompted by the much publicized announcement that Irving Trust Company had established ADR mechanisms for the securities of 34 different foreign issuers.' Shortly after the conference, the Commission adopted Form S-12, later replaced by Form F-6. Professor Loss describes the compromise embodied in these forms 'Under the current prevailing practice, the depositary banks vote proxies on the deposited securities in accordance with the specific instructions of ADR holders on payment of expenses. If no instructions are given, the proxies are not required to be voted or the depositary may vote them in its discretion. 'As explained below, the registration of the ADRs usually requires the foreign company to establish the information-supplying exemption in Rule 12g3-2(b). The depositary bank often acts as the agent to establish that exemption. "The fees the depositary charges may be set forth on the ADR certificate or on a separate schedule furnished to investors upon request. 'Section 4(1) exempts transactions by any person other than an issuer, underwriter, or dealer. Section 4(3) exempts certain transactions of a dealer following the completion of a distribution. "See Form F-6, General Instruction I.B. 'The transcript of the conference is in File No. 4-83-1. 194 ...when no person performs the acts or assumes the duties of depositor or manager pursuant to the instru- By adopting the Form S-12 and later Form F-6, the Commission recognized that ADRs are substitute certificates and acknowledged that trading transactions in the outstanding securities underlying the ADRs ordinarily would be exempt under Sections 4(1) and 4(3) of the Securities Act, and that the ability of U.S. investors to invest in foreign securities through the medium of ADRs was in the public interest. Form F-6 is a relatively simple form with only three primary limitations on its use: that the ADR holder be able to exchange the ADRs for the deposited foreign securities at any time, that the deposited foreign securities (if sold in the U.S.) would be either registered or exempt from registration under the Securities Act, and that the foreign issuer be either reporting or exempt by Rule 12g3-2(b) under the Exchange Act. Only a few items need be addressed in the prospectus: the identity of the depositary bank, the fees and charges of the depositary bank, and the terms of the deposit arrangement. The prospectus is the ADR itself. The depositary also undertakes to furnish to the Commission on a semiannual basis information with respect to issuances and retirement of ADRs and the identity of dealer depositors. Through the adoption of these Forms, the depositary banks achieved just about all they wanted and the Commission was able to preserve its regulatory control over ADRs.' B. Exchange Act of 1934 10 Similar to the treatment of ADRs under the Securities Act, the requirements for periodic reporting with respect to ADRs are minimal. Annual and other reports have not been required of the depositary banks as a result of registration statements on Form F-6, and, in view of the nature of such registration statements and the undertakings included therein, none appear needed. Depositary shares, but not the foreign securities, are exempt from Section 12(g) of the Exchange Act." If the ADRs are registered pursuant to Section 12(b) and listed on a U.S. securities exchange, a registration statement and annual reports on Form 20-F must be filed." Therefore, in general, there is no direct reporting requirement on the part of the foreign issuer of the underlying securities in an ADR arrangement unless its securities have been actually registered under either the Securities or the Exchange Acts. 'L. Loss, Fundamentals of Securities Regulation, 247-248 (1983). 'In 1961, the Commission sponsored another hearing on ADRs that related mainly to special problems involved in issuing ADRs for Japanese companies and in having several depositary banks with an ADR facility for the same foreign security. 1o Rule 15d-3. "Rule 12g3-2(c). 12See Form 20-F, General Instruction H. 195 1 Loss, Securities Regulations (2d ed. 1961, Supp. 1969) 460-465, 564-566. Greene and Ram, Two SEC Actions Significantly Affect Foreign Issuers, Legal Times, Dec. 6, 1982, at 20. Moxley, The ADR: An Instrument of International Finance and a Tool of Arbitrage, 8 Vill. L. Rev. 19 (1962). Tomlinson, Federal Regulation of Secondary Trading in Foreign Securities, 32 Bus. Lawyer 463 (1977). Note, SEC Regulation of American Depositary Receipts: Disclosure, Ltd., 65 Yale L.J. 861 (1956). OICF:29 196 |