By Frank Vivero and Casey Cohn
Frank Vivero is a partner and Casey Cohn is an associate at the law firm of Haynes and Boone, LLP in New York. The views expressed in this article are those of the authors and do not necessarily represent the views of, and should not be attributed to Haynes and Boone LLP. The authors may be contacted by email at firstname.lastname@example.org and email@example.com.
This article is for informational purposes only and is not intended to be legal advice. Transmission is not intended to create, and receipt does not establish, an attorney-client relationship. Legal advice of any nature should be sought from legal counsel. For more information about Haynes and Boone and our practice, please visit www.haybesboone.com.
In the late 20th century, U.S. financial markets were regarded as one of the best venues in the world for non-U.S. companies to raise equity and gain access to a large pool of investors with a view to improve liquidity, lower capital costs and gain visibility in an increasingly global marketplace. Dual or cross-listed1 non-U.S. companies often received a “cross-listing premium”—a higher market valuation in comparison to similar non-U.S. companies that are not cross-listed.2 The occurrence of several high profile corporate scandals at the start of the 21st century, followed by the banking debacle and ensuing global economic downturn, lead to increased corporate governance requirements and the passage of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”)3 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”)4 financial reform legislation. These new laws have increased the cost of maintaining a listing on a U.S. stock exchange at the same time that economic conditions and other factors have reduced the attraction of a U.S. listing for many non-U.S. companies. In addition, many dual and cross-listed companies with low U.S. trading volumes and share prices, reflecting limited investor interest, may no longer be achieving the expected cross-listing premiums and attendant visibility and liquidity gains historically associated with a U.S. stock exchange listing, despite greater analyst coverage.5
There are significant burdens associated with maintaining a U.S. stock exchange listing. These include management distraction and high costs arising from U.S. Securities and Exchange Commission (“SEC”) reporting rules, the disclosure and corporate governance requirements of the U.S. exchanges themselves, potential SEC investigations, U.S. shareholder litigation and potential U.S. federal securities law liabilities (e.g., under insider trading laws). Costs associated with SEC reporting rules, for example, include the cost of converting financial statements to eXtensible Business Reporting Language (XBRL), preparation of annual reports and periodic filings on Forms 20-F and 6-K and filing obligations of affiliates under Section 13(d) of the 1934 Securities Exchange Act, and the implementation of Section 404 of the Sarbanes-Oxley Act6, which requires management to thoroughly assess and report on a company's internal controls processes. These costs are magnified if a non-U.S. company inadvertently loses its foreign private issuer status and is required to comply with even stricter SEC regulations applicable to U.S. companies.7
The compliance costs associated with a listing on a U.S. stock exchange can be especially hard to justify in light of the availability of robust liquid markets and stock exchange listings outside the U.S. In addition, as securities markets have become increasingly globalized, there has been evidence of convergence in securities regulation. The benefits, in terms of perceived investor protection, that have traditionally accrued to non-U.S. companies willing to subject themselves to SEC regulation may be less tangible for companies located in countries and/or listed on international exchanges with developed investor protection regimes.
Two recent developments in the U.S. have also made it easier for non-U.S. companies to raise capital in the U.S. without being listed on a U.S. securities exchange. The first is the development and growth of over-the-counter trading platforms, which provide a credible alternative source of liquidity for investors in non-U.S. companies without requiring SEC registration. The second is the Jumpstart Our Business Startups (“JOBS”) Act8, enacted on April 5, 2012, which greatly expands the ability of companies to raise capital through private transactions that are not subject to registration under the Securities Act of 1933 (the “Securities Act”)9.
In light of these changes, dual and cross-listed non-U.S. companies may want to reassess their presence on a U.S. stock exchange. This article discusses some of the advantages of delisting from a U.S. stock exchange, deregistering with the SEC and listing on an OTC trading platform, and provides an overview of the process by which such a change would be accomplished.
To be admitted to the OTCQX International trading platform, a non-U.S. company must either be registered under Section 12(g) of the Exchange Act or must be a Rule 12g3-2(b) issuer.13 Rule 12g3-2(b) is a self-executing exemption from Exchange Act registration under Section 12(g) for foreign private issuers that have a primary non-U.S. listing and publish in English material information they make public in their home country.14 The ability to rely on Rule 12g3-2(b) allows issuers to provide transparency to U.S. investors at reduced cost, because they can piggy-back on disclosure they are already required to make under a non-U.S. regulatory regime. This means that even a small premium in trading price due to the presence on the OTCQX International may exceed the cost of Rule 12g3-2(b) compliance.
The OTCQX International also requires issuers to meet certain initial listing standards. To be considered for admission to the OTCQX International, an issuer must: (i) as of the most recent annual or quarterly period end, have $2 million in total assets; (ii) to qualify for the OTCQX International tier, as of the most recent fiscal year end, have one of the following: (a) $2 million in revenues; (b) $1 million in net tangible assets; (c) $500,000 in net income; or (d) $5 million in global market capitalization; (iii) to qualify for the OTCQX International Premier tier, as of the most recent fiscal year end, have one of the following: (a) (1) revenue of $100 million, (2) global market capitalization of $500 million, (3) aggregate cash flow for the three preceding years of $100 million, and (4) minimum cash flow in each of the two preceding years of $25 million; or (b) (1) revenue of $75 million and (2) global market capitalization of $750 million; (iv) have proprietary priced quotations published by a Market Maker in OTC Link; (v) have its securities listed on a qualifying foreign stock exchange for a minimum of the preceding 40 calendar days (OTC Markets Group may also consider individual requests to admit issuers traded on non-U.S. exchanges that are not qualified foreign stock exchanges); (vi) be eligible and compliant under Rule 12g3-2(b) or registered and compliant under Section 12(g) of the Exchange Act; (vii) be included in a recognized securities manual; and (viii) have common stock that meets any available exemption from the definition of a “penny stock” under Rule 3a51-1 under the Exchange Act.15
The OTCQX International platform includes approximately 400 companies trading electronically among broker-dealers.16 The aggregate market capitalization of these securities reached approximately $1.2 trillion in 2012.17 Large-cap non-U.S. issuers trading on the OTCQX International platform include: Adidas AG (market cap $23 billion, Frankfurt Stock Exchange); Roche Holding Ltd. (market cap $177 billion, Swiss Exchange), Danone (market cap $46 billion, Euronext, Paris), Imperial Tobacco Group PLC (market cap $33 billion, London Stock Exchange), Allianz SE (market cap $67 billion, Frankfurt Stock Exchange), Grupo Financiero Banorte (market cap $13 billion, Mexican Stock Exchange), AXA (market cap $50.5 billion, Euronext, Paris), BASF SE (market cap $82 billion, Frankfurt Stock Exchange), BNP Paribas (market cap $71 billion, Euronext Paris), BritishSky Broadcasting Group PLC (market cap $19.5 billion, London Stock Exchange), Cielo SA (market cap $19 billion, BM&F Bovespa), Deutsche Telekom AG (market cap $50 billion, Frankfurt Stock Exchange), E.ON SE (market cap $31 billion, Frankfurt Stock Exchange), Wal-Mart de Mexico S.A.B. de C.V. (market cap $49 billion, Mexican Stock Exchange), and Zurich Insurance Group Ltd. (market cap $39 billion, Swiss Exchange).18
One of the fundamental benefits of a public listing is transparency to investors. Accordingly, the continued provision of meaningful information to investors in compliance with Rule 12g3-2(b) and through an OTC trading platform can mitigate the impact of delisting from a U.S. securities exchange on the liquidity and price of a company's stock. To facilitate transparency, the OTC Markets platforms allow companies to combine financial results with stock price and trade data, all in one site. OTC Markets also provides a news service for issuers that is affiliated with PR Newswire and enables information published on the OTC Markets website to be distributed to other financial portals.19 Moreover, non-U.S. companies can adopt disclosure best practices and arrange for information to be directed to Regulation FD–compliant news portals and professional databases. Such disclosure will, of course, be most beneficial if it is readable and well-organized. With respect to annual reports, annual and quarterly financial information and other disclosure, non-U.S. companies with experience complying with SEC regulations can provide the same core information and structure as in past SEC filings, while eliminating unnecessary, duplicative and burdensome requirements. Although not required, issuers may want to consider publishing insider-ownership information on an annual basis.
These changes make it easier for non-U.S. companies to more widely market securities offerings and expand their pool of potential investors, issue such securities privately, and have such securities trade on an OTC platform without the issuer becoming subject to SEC reporting. The lifting of restrictions on the distribution of information regarding Rule 144A securities will facilitate trading on OTC marketplaces by broker-dealers for their own accounts and on behalf of other QIBs. Moreover, a general solicitation in connection with a Rule 144A offering will not be viewed as a “directed selling effort” in connection with a concurrent Regulation S offering outside the U.S. Non-U.S. companies will be able to conduct a secondary offering in the U.S. and outside the U.S. to existing investors and institutional investors with greater freedom.
These changes will also provide increased transparency to the market in general. Issuers will be able to include offering materials related to a private offering on a website and information vendors will be able to provide more information about Rule 144A securities, even though sales will be limited to QIBs.
The JOBS Act also lifts the thresholds for mandatory registration under Section 12(g) of the Securities Act, which can subject an issuer to SEC registration simply because of its size. Title V of the JOBS Act amends Section 12(g) with regard to issuers other than banks and bank holding companies to raise the threshold for the number of holders requiring registration from 500 or more persons to either (i) 2,000 or more persons or (ii) 500 or more persons who are not accredited investors.21 In calculating the number of holders of record, companies may now exclude persons who received securities pursuant to employee compensation plans in transactions exempted from registration under the Securities Act.
The SEC is empowered by Congress to enforce the U.S. securities laws, and over the years the SEC's enforcement powers have been significantly expanded. The SEC has the ability to seek treble damage penalties for insider trading violations and it can impose civil penalties in administrative proceedings for non-compliance with disclosure regulations. In addition, the SEC has “cease and desist” power, which allows it to order companies accused of violating any U.S. securities law to stop committing such violations immediately and vow never to commit such violations again.23
In addition, non-U.S. companies that are listed in the U.S. need to be concerned about the risk of private civil securities litigation. The well-developed class action mechanism available in the U.S. for securities fraud cases and an active plaintiff's bar create significant litigation risks to non-U.S. companies listed in the U.S. For many companies, an important part of the litigation risk is the expense and loss of management time involved in being sued, and ultimately the cost of settlement may be less expensive than mounting a successful defense. From July 1, 2012 to June 30, 2013, there were 21 securities class action filings against companies headquartered outside the U.S. Securities class actions are much more likely to be filed against companies listed on a U.S. stock exchange. During the first half of 2013, 87 percent of U.S. securities class action filings were against companies listed on the Nasdaq, New York Stock Exchange or NYSE MKT.24
Deregistering and conducting future offerings in the U.S. on a private basis will eliminate potential liability for misstatements or omissions of material fact in a registration statement filed under the Securities Act or report filed under the Exchange Act, as no such filings will be made. Moreover, deregistration will also relieve affiliates from filing obligations and liability under Section 13(d) of the Exchange Act. Disclosures made available in English as required by Rule 12g3-2(b) under the Exchange Act do not carry disclosure liability under Section 18 of the Exchange Act. Deregistered non-U.S. companies will remain subject to the anti-fraud provisions of Section 10(b) and Rule 10b-5 under the Exchange Act (regardless of whether their securities are listed on an OTC platform). However, U.S. courts have yet to impose Rule 10b-5 liability on an issuer based solely on its Rule 12g3-2(b) disclosure.25 While the majority of securities fraud cases brought in U.S. courts are premised on Section 10(b) of the Exchange Act, recent U.S. Supreme Court and federal court decisions have limited the circumstances under which non-U.S. companies can be subject to liability under Section 10(b).
In Morrison v. National Australia Bank, the U.S. Supreme Court affirmed dismissal of a Section 10(b) claim on the ground that Section 10(b) does not apply extraterritorially.26 The U.S. Supreme Court held that the statute applies only to “the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” This is described as the “transactional test.”27 Following the Morrison decision, U.S. district courts have relied on the transactional test to reject claims that a purchase or sale of a security on a foreign exchange takes place in the U.S. if the purchase or sale order is made from the U.S.28 as well as claims that if a non-U.S. company is dual or cross-listed on an American exchange, global class actions covering all foreign transactions in such shares are subject to Section 10(b).29 Most notably, the U.S. District Court for the Southern District of New York declined to apply Section 10(b) to the claims of U.S. purchasers of Level 1 ADRs in U.S. over-the-counter transactions.30
The Dodd-Frank Act included language intended to partly overrule Morrison. Section 929P(b) of the Dodd-Frank Act provides federal courts with “jurisdiction” to hear cases brought by the U.S. or the SEC that involve extraterritorial elements.31 This language, however, does not correspond with the Morrison holding. Morrison addressed the substantive reach of section 10(b), not the jurisdiction of federal courts.32 Therefore, the actual effect of Section 929P(b) is likely to be limited.33
The Form 25 suspends the issuer's SEC reporting obligations under Section 12(b) of the Exchange Act. However, as soon as such suspension is effective, other SEC reporting obligations are revived. Reporting obligations under Section 12(g) (which has historically applied to companies that have had more than 500 shareholders of record on a worldwide basis and total assets exceeding $10 million, but has been updated by the JOBS Act, as described below34 ) and 15(d) (for companies that have had a registration statement declared effective under the Securities Act) are suspended while obligations under Section 12(b) are in effect and obligations under Section 15(d) are suspended while Section 12(g) reporting obligations are in effect. Once the Section 12(b) or Section 12(g) filing obligations are terminated, the Section 12(g) or Section 15(d) filing obligations, respectively, become applicable again.
Non-U.S. issuers may choose one of two methods to deregister under both Sections 12(g) and Section 15(d). The first is provided under Exchange Act Rules 12g-4 (with respect to Section 12(g) registration) and 12h-3 (with respect to Section 15(d) registration), which are applicable to both U.S. and non-U.S. companies. Under those rules, a company's ability to deregister depends on its having less than 300 holders of record of the relevant class of securities, or less than 500 holders of record if the company's total assets have not exceeded $10 million on the last day of each of the three most recent three fiscal years. In computing the number of record holders, companies may use the counting method set forth in Rule 12g5-1 that does not look through the holdings of brokers, dealers, banks or other nominees to beneficial owners. As a result, a company may have many more than 300 security holders but still be deemed to have less than 300 holders of record. In addition, Rule 12h-3 requires that the company be current in all SEC filing obligations for the most recent three fiscal years and the portion of the current year preceding deregistration, and that the company did not have a registration statement declared effective or required to be updated pursuant to Section 10(a)(3) of the Securities Act during the applicable fiscal year. Such updating can occur automatically by means of the incorporation by reference of an annual report on Form 20-F into a company registration statement. Thus, to be eligible to use Rule 12h-3 in a given fiscal year, the company must either not yet have filed its Form 20-F for the prior fiscal year ended or have terminated any registration statements that would incorporate such filing by reference prior to filing such Form 20-F.
The second method of deregistration, which is only available to non-U.S. companies, is provided under Rule 12h-6. Under Rule 12h-6, the company must (i) have been registered with the SEC for at least one year, have filed at least one annual report (Form 20-F) and filed or furnished all other required reports, (ii) have a primary trading market outside the U.S. that constituted at least 55 percent of its trading during the prior 12 month and (iii) not have sold any company securities in a registered offering during the prior 12 months. In addition, either (i) the average daily trading volume of the subject class of securities in the U.S. for a recent 12-month period must have been no greater than 5 percent of the average daily trading volume of that class of securities on a worldwide basis for the same period, or (ii) on a date within 120 days before the filing date of the Form 15F (described below), the subject class of securities must have been held of record by less than 300 persons either on a worldwide basis or in the U.S. For purposes of calculating the number of record holders, Rule 12h-6 provides a method of counting residents in the U.S. that requires a modified look through of nominee holders to the underlying beneficial owners. The company must make an inquiry to nominees to look through to the number of holders of securities held by U.S. residents in the accounts of brokers, dealers, banks and other nominees, except that the inquiry can be limited to brokers, dealers, banks and other nominees located in the U.S., in the company's jurisdiction and in its primary trading market. Companies may rely on third-party service providers engaged for the purpose of assisting the company in determining U.S. holdings.
If a company is eligible to use either method described above, it may be preferable to use Rule 12h-6, which actually terminates (rather than suspends) Section 15(d) reporting obligations, as described below.
To deregister under Rules 12g-4 and 12h-3, the company must file a Form 15. A Form 15 filing automatically becomes effective after 90 days, or within a shorter period that may be designated by the SEC. During this time, unless notified that the SEC has denied the termination of registration, the issuer is not required to file Forms 20-F and 6-K. If the Form 15 is denied, the company would have 60 days to catch up on such filings. If it was previously registered under Section 12(b) or 12(g), the company will continue to be subject to Section 13(d) and Section 13(e) requirements during the 90 day period. Non-U.S. companies that fail to qualify as foreign private issuers will also be subject to the proxy rules and Section 16 reporting and short-swing profit liability. Issuers that were reporting only under Section 15(d)—because they have had an effective registration statement—would not be subject to these additional requirements during the 90 day period. When the Form 15 becomes effective, the company's registration under Section 12(g) is terminated. It's reporting obligations under Section 15(d) are suspended, not terminated. If the number of record holders of the applicable class of equity securities later exceeds 300 record holders at the beginning of any fiscal year, and no exemption is available, the company's reporting obligations are automatically reactivated. However, a non-U.S. company that complies with Rule 12g3-2(b), described under “Improved OTC Trading Platforms” above, will be exempt from such reactivation.
To deregister under Rule 12h-6, the company must file a Form 15F. A Form 15F becomes effective within the same time period and conveys the same interim suspension of filing obligations as a Form 15. Either before or at the time the Form 15F is filed, the company must provide public notice that it intends to deregister. Such notice must be published through a means “designed to provide broad dissemination of the information to the public in the United States,” such as a press release. The company must submit a copy of the notice to the SEC, either as a Form 6-K filing, or as an exhibit to the Form 15F when it is filed.
A described above, the company will be required to re-register a class of securities under Section 12(g) of the Exchange Act only if, as of the last day of its fiscal year, it has over $10 million in assets and such class is held by more than (i) 2,000 shareholders of record or 500 shareholders of record who are not accredited investors, and (ii) 300 U.S. residents. 35 An issuer that qualifies under the Rule 12g3-2(b) is not required to comply with SEC reporting requirements. Issuers deregistering under Rule 12g-4 or Rule 12h-6 may immediately claim the Rule 12g3-2(b) exemption upon the effectiveness of their Form 15 or Form 15F.
The regulatory and OTC developments described above provide enhanced opportunities for non-U.S. companies to raise capital through private offerings and maintain liquidity through an OTC trading platform without the burdens of being a U.S. reporting company. Delisting from a U.S. stock exchange, deregistering from the SEC reporting system and moving to an OTC platform may be particularly compelling for dual or cross-listed non-U.S. companies with low U.S. trading volume and/or stock price that are subject to adequate disclosure and antifraud regulation outside the U.S. Moreover, non-U.S. companies that do not benefit from cross-listing premiums may be the least likely to observe meaningful declines in value after delisting and deregistration since the marginal cost of the additional U.S. regulation associated with being a listed company is greater than the realized premium investors are willing to pay for the company's continued presence on a U.S. stock exchange.
It is important to underscore that leaving the SEC reporting system is not what is referred to as “going dark” or “going private.” Non-U.S. companies can leave the SEC reporting system, maintain their non-U.S. listing, amend their deposit agreement if its ADSs are listed, trade on an OTC platform in the U.S. and provide public disclosure of material information in a way that piggy-backs on disclosure made outside the U.S. Although minority shareholders may have concerns about a decision to exit the SEC reporting system, continuing to provide disclosure of material information and transitioning to an OTC platform should at least partially address these concerns.
1 Cross-listed companies' shares trade primarily on a local exchange, but are also traded through a secondary listing on an exchange in another country, generally in the form of depositary receipts (if the secondary listing is in the U.S., for example, these will be American Depositary Receipts). Dual-listed companies have their shares directly listed on multiple stock exchanges.
2See Craig Doidge, Andrew Karolyi, & Rene Stulz, Why Are Foreign Firms Listed Abroad in the U.S. Worth More?, J. Fin. Econ. 71, 205-238; (2009).
3 Pub.L. 107–204, 116 Stat. 745 (2002).
4 Pub.L. 111–203, 124 Stat. 1376 (2010).
5 At least one empirical study has found that cross-listing premiums decline significantly for most non-U.S. companies during the first six years after a U.S. listing, and may disappear entirely after six years with the greatest decay found for non-U.S. companies with below-median U.S. trading volumes. See Katherine Litvak, The Relationship Among U.S. Securities Laws, Cross-Listing Premia, and Trading Volumes, European Summer Symp. Fin. Markets (July 13-24, 2009), available at http://dev3.cepr.org/meets/wkcn/5/5567/papers/LitvakFinal.pdf.
6 Pub.L. 107–204, 116 Stat. 789 (2002).
7 When a non-U.S. company loses its foreign private issuer status it becomes subject to the SEC proxy rules, Section 16 insider reporting and the revamped executive compensation rules, which require extensive disclosure of executive compensation and provide shareholders with a regular vote on such compensation.
8 Pub.L. 112-106, 126 Stat. 306 (2012).
915 U.S.C. §77a.
10 OTCQX International. http://www.otcqx.com/qx/int/overview (last visited August 1, 2013).
11 OTCQX Requirements & Fees. http://www.otcqx.com/qx/int/requirements (last visited August 1, 2013).
12 OTCQX International, supra note 10.
13 OTCQX Requirements & Fees, supra note 11.
14 17 CFR 240.12g3-2.
15 Supra note 11.
16 List of OTCQX Companies, http://www.otcqx.com/qx/market/otcqxList (last visited August 1, 2013).
18 List of OTCQX Companies, http://www.otcqx.com/qx/market/otcqxList (last visited August 1, 2013).
19 Supra note 10.
20 A copy of the SEC's final rule amendments on general solicitation and Rule 506 is available at the following link:http://www.sec.gov/rules/final/2013/33-9415.pdf.
26 See Morrison v. Nat'l Austl. Bank, 130 S.Ct. 2869, 2884 (2010) (“We know of no one who thought that the Act was intended to “regulat[e]” foreign securities exchanges—or indeed who even believed that under established principles of international law Congress had the power to do so…”) In Morrison, foreign citizens sued a foreign issuer in the United States for alleged fraud under Section 10(b) in connection with securities transactions in a foreign country.
27 See Morrison v. Nat'l Austl. Bank, 130 S.Ct. 2869, 2886-2888 (2010)
28 Cornwell v. Credit Suisse Grp., 729 F. Supp. 2d 620, 624 (S.D.N.Y. 2010); In re UBS Sec. Litig., No. 07 Civ. 11225 (RJS) at *7-*8 (S.D.N.Y. Sept. 13, 2011); In re Vivendi Univ., S.A. Sec. Litig., 765 F. Supp. 2d 512, 532-33 (S.D.N.Y. 2011); In re Royal Bank of Scotland Grp. PLC Sec. Litig, 765 F. Supp. 2d 327, 336-37 (S.D.N.Y. 2011); Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 753 F. Supp. 2d 166, 177-78 (S.D.N.Y. 2010); In re Soci
To view additional stories from Bloomberg Law® request a demo now