A Regulatory Gift as Sarbanes-Oxley Turns 5 Years Old
In response to the compliance regulatory load from the Sarbanes-Oxley Act (SOX) and the changing global capital markets, too, the Securities Exchange Commission (SEC) recently adopted new rules making it easier for foreign private issuers1 to de-register as reporting companies in the United States. Effective June 4, 2007, foreign private issuers may now permanently de-register using new quantitative benchmarks to determine eligibility.
Among the stated purposes of the rule, the SEC hopes to encourage foreign private issuers to initially and continue to list their stocks in the U.S. market while reducing the regulatory burden under the Exchange Act. In addition, the SEC hopes that the new rules will provide better certainty to foreign private issuers that a choice to leave the U.S. regulatory world will be a permanent rather than a temporary result. Under the new rules, a foreign private issuer may terminate, rather than merely suspend, Exchange Act reporting obligations. Additionally, the new rules introduce the Average Daily Trading Volume as an alternative to the 300 Record Holder threshold making it easier for issuers to qualify for de-registration.
In this advisory:
- What You Need to Know Now
- Equity Securities
- Debt Securities
- Determining Record Holders
- Procedure for De-Registration
To read the SEC’s final rule, click here.
While many can and do debate whether SOX has been good or bad for capital markets, investor protection and the like, no one can seriously debate that the compliance regulatory burden has been enormous and a particular bane of smaller public companies, including public companies that travel in international capital markets. For foreign private issuers with the majority of their management and operations similarly outside the United States and having some presence on U.S. capital markets—whether that be a full listing on the Nasdaq or NYSE or a smaller profile on the OTC—regulatory issues can be especially frustrating and expensive as such companies have to comply with different and sometimes conflicting requirements. As a result, over the five years since SOX was birthed, more and more foreign private issuers have avoided the U.S. capital markets and regulatory environment entirely and those that have been here previously have left.
On June 4, the (SEC) made that exit easier when it adopted new rule 12h-6 (the “Rule”). The SEC believes that by making it easier for foreign private issuers to terminate their reporting status under the Exchange Act, more foreign private issuers will initially enter and ultimately remain in the US trading markets, thereby providing US investors with more investment opportunities. While it remains to be seen whether that goal will be achieved, it appears that the first objective has been met as companies are lining up at the SEC to terminate their reporting status under the Rule.
It is clear that SOX—and in particular the internal controls provisions under Section 404—has been a large deterrent to foreign companies listing stocks in the United States. It has also provided a large and increasing impetus to leave the United States when the size of the company’s trading presence in the United States is relatively small—and the ability to secure necessary capital can be found in non-U.S. capital markets.
Attempts to avoid continued reporting obligations after a foreign private issuer’s U.S. market trading activity drops below a certain level have been likened to a visit to the Hotel California—you can check out, but you can never leave. Moving towards a more global economy, foreign private issuers view the possibility of the reporting obligations under the Exchange Act as daunting and a deterrent to listing in a U.S. market. Unsurprisingly, in 2005 only one of the 25 largest initial public offerings (IPOs) took place in a U.S. market. To illustrate further, London’s Alternative Investment Market had 335 IPOs in 2005—doubled its total in 2000—and NASDAQ dropped 65 percent to 126 over the same period. The SEC hopes to reverse this trend and make U.S. capital markets more desirable and increase investor choice by taking steps, including the adoption of the Rule, that make the compliance meal more palatable.
Most importantly, the new Rule provides an easier and more permanent mechanism to terminate its reporting obligations under the Exchange Act. Previously, a foreign private issuer could de-register only if the number of U.S. shareholders was below certain thresholds—and, more importantly, stayed that way. Regardless of the trading volume in the United States, the difference between having one less shareholder than the stated threshold and having one more was enormously significant. In the case of having one more than the threshold, (a) you could not avoid the reporting obligations under the Exchange Act, and (b) even if you had less than the stated threshold at one time and thus qualified for de-registration, you could find yourself having to re-enter the Exchange Act reporting world if the number increased beyond the threshold.
Among the more significant changes, the Rule introduces the Average Daily Trading Volume as an alternative to the 300 Record Holder threshold, making it easier for foreign private issuers to qualify for de-registration. Other conditions include a 12-month prior reporting condition, a 12-month dormancy period, and a foreign listing condition. Finally, the Rule sets forth requirements for maintaining the exemption obtained through the Rule. Each of these changes is discussed in turn below.
A foreign private issuer may de-register a class of equity or debt securities under section 12(g) of the Securities Exchange Act of 1934 and the corresponding duty to file reports required under 13(a). The Rule permits a foreign private issuer of equity securities to terminate its reporting obligations under either section 13(a) or 15(d) of the Act by meeting a quantitative benchmark designed to measure U.S. market interest for its equity securities that does not depend on a head count of the issuer’s U.S. security holders. The Rule also permits a foreign private issuer of debt securities to terminate its section 15(d) reporting obligations. Moreover, under the Rule, a foreign private issuer that de-registers will not be involuntarily drawn back into the reporting scheme.
What You Need to Know Now
- A foreign private issuer may terminate its reporting requirements under the Securities Exchange Act of 1934 by filing a Form 15F.
- Filing the Form 15F suspends the issuer’s reporting obligations under the 1934 Act and rules of the exchanges until the earlier of (a) the request becomes effective or (b) the SEC rejects the request.
- A foreign private issuer must satisfy and support the following requirements in its Form 15F:
- The issuer must have had reporting obligations under 13(a) or 15(d) for at least the 12 months preceding the filing of Form 15F;
- The issuer must have filed at least one annual report while it was registered;
- The issuer must not have effected a registered offering in the United States for the 12 months preceding the filing of the Form 15F (note that other than certain securities issued such as those to employees and exempt offers are permitted); and
- The issuer must have filed or furnished all reports required for the 12-month period preceding the filing of Form 15F.
Quantitative Benchmark Condition
The newly introduced Average Daily Trading Volume (ADTV) standard looks to a 12-month period to calculate the ADTV. A foreign private issue meets this threshold eligibility requirement if the U.S. ADTV has been no greater than 5 percent of its worldwide trading volume.
A foreign private issuer must wait 12 months before filing its Form 15F in reliance on the ADTV standard if the issuer has de-listed its class of equity securities from a national securities exchange in the United States, terminated a sponsored ADR facility or, at the time of de-listing, the U.S. ADTV exceeded 5 percent of its worldwide ADTV.
The rules retain the record holder benchmark as an alternative to the trading volume benchmark with some significant changes in counting methodology. The methodology is discussed in more detail below.
Prior Reporting Condition
A foreign private issuer must have been subject to Exchange Act reporting obligations for at least one year, be current in reporting obligations for that period, and have filed at least one annual report.
Additionally, a foreign private issuer may not publicly sell securities for at least 12 months preceding the Form 15F filing. The Rule permits the unregistered sale of securities exempted under the Act during this dormancy period.
Foreign Listing Condition
Finally, a foreign private issuer must have maintained a listing in a primary market in its foreign jurisdiction for at least 12 months preceding the Form 15F filing. Primary trading market is defined as a market where at least 55 percent of the trading takes place. It may also be determined through aggregation. However, an issuer may combine no more than two foreign jurisdictions and may aggregate only within the same class of securities.
Maintaining 12g3-2(b) Exemption
Upon approval of the Form 15F, an issuer is automatically exempt from reporting obligations. An issuer must electronically publish specified home country documents in English in order to maintain the exemption.
As adopted, the Rule will enable a foreign private issuer to terminate its Exchange Act reporting obligations regarding a class of debt securities. There are only two conditions a debt securities issuer must satisfy before de-registering. They include (1) the 300 Record Holder condition and (2) the prior reporting condition. An issuer also must satisfy the “prior reporting condition” if it issues debt or equity securities.
The Rules retain the 300 Record Holder standard for a debt securities issuer as the quantitative standard. Increasing the threshold number and adding a trading volume benchmark as an alternative were both explicitly rejected in regards to debt securities.
Determining Record Holders
The Rule allows a modified “look through” counting method to determine the number of U.S. resident security holders. This reduces the required inquiry into the residency of the record holders. Additionally, the Rule allows an issuer to rely on independent information services providers for counting. To determine the primary trading market, look to the rules set forth for calculating ADTV.
Furthermore, the Rule adopts a principal place of business presumption. If, after reasonable inquiry, an issuer is unable to obtain information about the amount of securities held by nominees for the U.S. resident accounts, it may assume that the customers are residents of the jurisdiction in which the nominee has its principal place of business.
Procedure for De-Registration
A foreign private issuer seeking to terminate its registration and reporting obligations must file new Form 15F on EDGAR. The issuer must provide information supporting its determination that it meets the requirements.
Filing a Form 15F immediately suspends an issuer’s Exchange Act reporting obligations regarding the subject class of securities and commences a 90-day waiting period. If at the end of this 90-day period the SEC has not objected to the filing, the suspension will automatically become a termination. The SEC may elect to make a determination in fewer than 90 days or an issuer may request that the commission accelerate the period. If the commission denies the Form 15F, the issuer will have 60 days to file or submit all reports that would have been required had it not filed the Form 15F.
An issuer must publish a notice announcing its intention to terminate its reporting obligations under 12h-6 prior to or concurrently with Form 15F.
De-Listing Waiting Period
An issuer must de-list before it can de-register. If the issuer is currently listed on the NYSE or NASDAQ, it would first be required to file a Form 25 with the SEC to de-list and terminate its reporting obligations under 12(b) as well as satisfying certain other NYSE and NASDAQ de-listing requirements. De-listing would become effective 10 days after the Form 25 is filed with the SEC. If an issuer meets the ADTV standard, it may concurrently de-list from the exchange, and de-register.
An issuer of equity securities is subject to a 12-month waiting period under certain circumstances. To reduce any incentive for foreign private issuers to de-list from a U.S. exchange for the specific purpose of decreasing its U.S. trading volume, the final rule requires that, if an issuer’s securities have been de-listed within one year prior to filing a Form 15F, the foreign private issuer must satisfy the Trading Volume standard as of the date of the de-listing and for the preceding 12 months.
The Rule will principally benefit dually-listed companies because the rules are conditioned upon having a primary trading market outside the United States. Moreover, the ability to terminate rather than suspend reporting obligations should decrease foreign unease about registering with the SEC in the first place, thus increasing investor choice. And, the alternative quantitative benchmarks should make it easier to qualify. The SEC expects as many as 25 percent of Form 20-F filers to be eligible. However, the new Rule may have limited applicability where American investors have purchased a significant portion of the company’s shares through purchases made on the issuer’s home country stock exchange.
1 Foreign private issues are defined roughly as companies that are incorporated outside the United States, with the majority of their management and operations similarly outside the United States and having some presence on U.S. capital markets, whether that be a full listing on the Nasdaq or NYSE or a smaller profile on the OTC.