UK: Establishing A Level-1 American Depositary Receipt Program In The United States

Last Updated: 26 May 1999

Introduction

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 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. 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.

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: (a) accept shares deposited with the custodian (frequently a branch of the Depositary) in the company’s home country and issue ADRs in respect thereof; (b) register transfers of ADRs; (c) convert dividend payments into US dollars and distribute them to ADR holders; and (d) mail to such holders English versions of shareholder reports and proxy materials.

The unit in which US ADR-holders 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 financial advisers as to the appropriate trading price for the ADR in the United States.

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 or Nasdaq;

Level-2 ADR programs, which are listed on a US securities exchange (such as the New York Stock Exchange or the American Stock Exchange) or Nasdaq; and

Level-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 of Nasdaq) 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.

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 or quoted through Nasdaq. 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.

What are the US Securities laws registration requirements?

A non-US company establishing an ADR program will be required to register with the US Securities and Exchange Commission ("SEC") under Section 12 of the Exchange Act, or establish an exemption therefrom. Such an exemption is not available in the case of securities listed on a US securities exchange or Nasdaq. Therefore, Level-2 and Level-3 ADR programs must be registered; however, because Level-1 ADRs are not listed on an exchange or Nasdaq, a Level-1 ADR program can be exempted from the registration requirements of the Exchange Act. Accordingly, as more fully described below, an exemptive request must be prepared and submitted to the SEC.

Exemption from registration under the Exchange Act

Under Section 12 of the Exchange Act, a foreign private issuer with total assets exceeding $1 million and a class of equity security held of record by 500 or more world-wide shareholders (at least 300 of which are in the United States) becomes subject to the registration and reporting provisions of the Exchange Act. Rule 12g3-2(b) exempts the issuer from these requirements if the issuer furnishes to the SEC copies of certain documents that it is required to make public in its home country (e.g. shareholder reports, certain press releases and public domestic stock exchange filings).

With the first submission of such documents to the SEC, the company also includes a list identifying the information referred to above and stating when and by whom such information is required to be made public, filed with an exchange or distributed to security holders (this list is to be updated annually as necessary) and setting forth information concerning the number of holders of equity securities resident in the United States and related information. In addition, issuers must provide the SEC with English translations or summaries of information that is sent to shareholders, made public in the home market or provided to a local exchange. Furnishing this information to the SEC does not, however, constitute an admission that the company is subject to the requirements of the Exchange Act.

Approximately four to six weeks after the submission is made under Rule 12g3-2(b), the SEC will send a letter to the company formally acknowledging the exemption and providing a file number to which subsequent submissions should refer. Subsequent submissions to the SEC should be made promptly after the relevant information is made or is required to be made public as described above.

Regustration under the Securities Act

Although the company may be exempted from Exchange Act registration pursuant to 12g3-2(b), the Depositary and the company must register the ADSs evidenced by the ADRs under the Securities Act on Form F-6, a very brief document which includes the Deposit Agreement and ADR certificate.

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. 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 fifty US states.

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.

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, an non-US company could decide to register the securities under the Securities Act.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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