The U.S. capital markets remain the largest in the world, with U.S. equity markets representing 42.6% of global equity market capitalization, almost four times the size of the E.U., the next largest market.[1] The size and scope of the U.S. equity markets, coupled with its premier investment culture, has led to foreign equities comprising over $11 trillion of total U.S. portfolio holdings.[2] For that reason, foreign companies are eager to make their shares available to the broadest pool of U.S. investors. As buying foreign shares directly in a local market is cost prohibitive for most U.S. investors, foreign company shares are made available through American Depositary Receipts (ADRs) or the quoting of their ordinary shares (known as “F” shares) in U.S. markets.
OTC Markets Group operates the largest stock market in the U.S. for international companies, and serves as a global gateway for foreign companies seeking access to the U.S. equity capital markets. As of Q3 2024, international equities represented 92% of total volume on our markets, up from 84% in Q3 2023.[3] These growing figures highlight the tremendous value that companies and investors have found in trading these securities on our markets.
Convenient and simple, ADRs and foreign ordinary shares are nonetheless securities trading within the borders of the U.S., and foreign companies considering the U.S. market often inquire about any risk posed by U.S. federal securities laws. For such companies, the focus should not be on sidestepping the reach of U.S. securities laws but rather on ensuring compliance through Rule 12g3-2(b), and companies should steer their counsel to prioritize proactive compliance measures rather than strategies of avoidance.
Controlling Your U.S. Disclosure – The 12g3-2(b) Exemption
Rule 12g3-2(b) has proven transformative for foreign issuers seeking to tap into the U.S. market while maintaining compliance with U.S. securities laws, without taking on the burden of extensive SEC regulatory reporting. Under the rule, which is also known as the “foreign private issuer exemption”, qualifying foreign companies may trade in the U.S. by making their home market disclosure publicly available to U.S. investors in English. Unlike foreign companies that choose to register their securities in the U.S. and face significant ongoing obligations as a result – including the costly process of converting financial reporting into U.S. GAAP and meeting Sarbanes-Oxley internal control requirements – the foreign private issuer exemption enables qualifying issuers to access U.S. investors by utilizing their home country disclosure.
Notably, courts have emphasized that issuers making disclosures pursuant to 12g3-2(b) are not required to make disclosures to U.S. investors that they are not required to make under the laws of their home country.[4] This reinforces the principle that U.S. securities laws do not impose disclosure obligations beyond those mandated by an issuer’s domestic regulations.
Foreign companies that instead choose to maintain an exchange listing in the U.S. must meet extensive ongoing reporting and compliance requirements that often surpass those required by their home country exchange. By leveraging 12g3-2(b) and publishing their disclosure in English in the U.S.[5], companies can trade their ADRs and foreign ordinary shares without the cost and complexity of listing on a national securities exchange like NYSE or Nasdaq. Rule 12g3-2(b) also simplifies the process of investing in foreign stocks, as shares are traded in U.S. dollars and settle under U.S. market rules, eliminating the need to engage directly with foreign exchanges, open international brokerage accounts and pay the higher costs of custody, clearing and currency conversions.
Rule 12g3-2(b) exemplifies how foreign companies can easily expand their market reach while preserving their resources and flexibility. By controlling the flow of information in the U.S., companies can minimize their risk under U.S. securities laws. This is true even for unsponsored ADRs, where a company may not even be aware that its securities are being traded in the U.S., but still grapple with U.S. securities law risk.
The Risk and Reach of U.S. Securities Laws
This issue has been borne out in a number of cases that have been argued over the last 15 years (mostly involving ADRs), which grew out of the U.S. Supreme Court’s decision in NAB v. Morrison. The Morrison case limited the extraterritorial reach of U.S. securities law, establishing that the primary antifraud provision under U.S. securities law (Rule 10b-5) applies only to transactions in securities listed on national exchanges such as NYSE and Nasdaq, and to certain domestic transactions in other securities.[6]
The most frequently discussed case involved Volkswagen, the German carmaker that became embroiled in an emissions fraud scandal. U.S. investors in Volkswagen’s ADR sued after it was revealed that Volkswagen had installed software in its diesel vehicles to cheat emissions tests, misrepresenting the environmental impact of their cars. Unsurprisingly, the massive fraud evident in this case ultimately subjected Volkswagen to U.S. shareholder liability.[7]
Similarly, after Japanese company Toshiba faced a significant accounting scandal in its home country, U.S. investors in its unsponsored ADR brought suit against the company. In Stoyas v. Toshiba, Toshiba argued that it had no role in the creation of the unsponsored ADRs traded in the U.S. and that the case should be dismissed. The court allowed the case to move forward, although it remains unresolved.[8]
The Volkswagen and Toshiba cases each revolved around widespread corporate fraud. Following these cases, foreign companies seeking to access the immense benefits of the U.S. capital markets may have questions. Some law firms advise a strategy of avoidance, suggesting that companies completely forgo the U.S. investor base. That is akin to arguing that someone worried about getting a speeding ticket should never drive their car, instead of just taking care to drive the speed limit.
Of course, any company committing fraud, as in the Volkswagen and Toshiba cases, should be concerned about liability – in its home country and in the U.S. Most foreign companies, however, do not contend with this issue. Instead, companies should take care to demonstrate their compliance through clear, thoughtful disclosure – a practice most currently follow in their home jurisdictions.
As unsponsored ADR programs demonstrate, foreign company shares may trade in the U.S. even without the company’s involvement. It is therefore vitally important for non-U.S. companies to take control of the disclosure – financial or otherwise – that is made available to their current and prospective U.S. investors.
Successful Companies Have Blazed the Trail
Many foreign companies, including well-established multinationals like Roche (OTCQX: RHHBY; RHHBF), Adidas (OTCQX: ADDYY; ADDDF), and Heineken (OTCQX: HEINY; HINKF), have taken advantage of the 12g3-2(b) exemption and chosen to have their ADRs and foreign ordinary shares traded on our top market, OTCQX, understanding that the value of access to U.S. capital markets can far outweigh any associated legal or regulatory risk. It would be short-sighted to focus solely on companies that have faced lawsuits and ignore the numerous companies that have embraced their U.S. investors and continue to thrive. These companies’ successes demonstrate that a thoughtful, disclosure-based approach to building a U.S. market can make ADRs and foreign ordinary shares an easy and compelling option for improving liquidity and valuation, increasing trading volume, and reaching more U.S. investors.
As these profitable companies can attest, the root cause of any legal action and its success will be whether a company commits fraud, not the mere presence of its shares on U.S. markets.
By embracing transparency, fostering an internal culture of compliance, and adhering to U.S. regulatory standards for foreign issuers, foreign companies can not only mitigate legal risks but also build trust with U.S. investors, paving the way for long-term success in the U.S. equity capital markets.
To learn more about the advantages of joining OTCQX or OTCQB, please contact sales@otcmarkets.com
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