On August 27, 2008, the U.S. Securities and Exchange Commission (SEC) adopted rule changes to update and modernize disclosure and other requirements for foreign issuers in the U.S. markets. The rule changes are seen as the culmination of a significant project by the Staff of the Commission to provide greater accessibility to information about foreign issuers in light of technological changes and globalization of the securities markets. Amendments to existing rules focus on three main areas: (1) how a foreign issuer becomes subject to U.S. federal securities laws; (2) how foreign issuers report information to regulators, the markets and investors; and (3) how U.S. investors can participate in cross-border exchange and tender offers, as well as rights offerings.
Specifically, the rule changes take the following action:
- Modernize and simplify the process by which foreign private issuers can obtain an exemption under Rule 12g3-2(b) from the registration requirements of Section 12(g) of the Securities Exchange Act of 1934 (Exchange Act)
- Simplify the rules to enable once-a-year testing of “foreign private issuer” form eligibility and filing status
- Shorten the deadline for filing annual reports on Form 20-F from six to four months
- Enhance disclosures by foreign private issuers regarding changes in and disagreements with certifying accountants in annual reports and registration statements
- Limit and eventually phase out the use of Item 17 of Form 20-F relating to financial statements requirements
- Add additional disclosure items to Form 20-F
- Broaden the exemptions for cross-border transactions
- Simplify beneficial ownership calculation and reporting requirements in cross-border transactions and allow specified foreign institutions to report beneficial ownership on Schedule 13G to the same extent as their U.S. institutional counterparts
In addition, the SEC agreed to publish a proposed “roadmap” for the potential adoption of International Financial Reporting Standards (IFRS) for U.S. issuers in 2014.
Amendments to Rule 12g3-2(b)
Rule 12g3-2(b) provides an exemption from the registration requirements of Exchange Act Section 12(g). The exemption is used principally by companies with no U.S. listing of their equity securities. The exemption allows foreign private issuers to have their equity securities traded in the United States. over-the-counter (OTC) market without subjecting themselves to Exchange Act registration. The rule amendments will eliminate the 40-year-old written application and paper submission requirements under Rule 12g3-2(b) and automatically exempt foreign private issuers from Section 12(g) provided they meet specified conditions. As is currently the case, issuers must continue registering their securities under the Exchange Act to have them listed on a national securities exchange or traded on the OTC Bulletin Board. Changes to the rule were adopted substantially as proposed in February 2008. In order to qualify under the amended rule, a foreign issuer must meet the following conditions:
Primary Trading Market Outside the United States
An issuer must have the subject class of securities listed on one or more non-U.S. exchanges that qualify as the issuer’s primary trading market. “Primary trading market” is defined as a single foreign jurisdiction (or, alternatively, in no more than two foreign jurisdictions) in which at least 55 percent of the trading occurred for the subject securities during the most recently completed fiscal year. This requirement is intended to ensure that there exists a non-U.S. regulator who will assure that the foreign issuer prepare and make publicly available material information on a timely basis to investors (including U.S. investors).
Posting of Documents in English on Issuer’s Website
The amendments also require a newly exempt issuer to publish in English, either on its website or through another publicly available electronic delivery system, specified non-U.S. disclosure documents from the beginning of its most recently completed fiscal year to date and, to maintain the exemption, to publish the specified information on an ongoing basis for subsequent years.
No Existing U.S. Reporting Obligations
While the amended rule continues the current requirement that an issuer not otherwise have any reporting obligations under Section 13(a) or 15(d) of the Exchange Act, an issuer will no longer be required to look back 18 months to assess whether it had any active or suspended reporting obligations during that period.
A fourth condition to eligibility, based on U.S. average daily trading volume, was not adopted.
The final rule is expected to include a three-year transition period for companies currently claiming the exemption in order to accommodate the new trading market eligibility requirements. In addition, issuers will be granted a three-month transition period in order to allow time to comply with the new disclosure requirements.
Foreign Issuer Reporting Enhancements
The SEC also adopted the Foreign Issuer Reporting Enhancement (FIRE) proposals, which effect changes in the content and timing of disclosure requirements for foreign private issuers. The most significant changes include the following:
- Determination of status annually rather than continuously. In an effort to provide greater certainty both for issuers and the markets as to a company’s eligibility to use the special forms and rules applicable to “foreign private issuers,” the SEC agreed that the determination would be made on the last business day of the issuer’s second fiscal quarter. This coincides with the reference date used by domestic reporting companies in determining accelerated filer and small business reporting company reporting status. Currently, foreign private issuers are required to continually monitor their eligibility and status as a “foreign private issuer.” Under the amended rule, if a foreign private issuer fails to qualify as a foreign private issuer as of the last business day of its second fiscal quarter, then it must comply with the forms and rules applicable to domestic issuers as of the first day of its next fiscal year. This permits a foreign private issuer a six-month transition period to ready itself for the domestic reporting requirements (including U.S. GAAP financial reporting).
- Acceleration of filing deadline for Form 20-F. The deadline for filing an Annual Report on Form 20-F has been reduced from the current six months after fiscal year-end to four months. The SEC considers the shortened time period appropriate given that the home country annual reporting requirements of many reporting foreign issuers is not longer than four months. In addition, foreign issuers filing under IFRS (as adopted by the IASB) no longer are required to reconcile their financial statements to U.S. GAAP, which should facilitate a more timely completion of the Form 20-F. The change in the Form 20-F deadline is expected to be subject to a three-year transition period and, therefore, applicable for fiscal years ending on or after December 15, 2011.
- Limitation on scope and use of Item 17 financial statements. Item 17 of Form 20-F previously allowed foreign private issuers to omit segment data from U.S. GAAP-compliant financial statements. In order to provide a consistent U.S. GAAP reconciliation procedure, the SEC voted to eliminate Item 17 entirely after a three-year phase-out period. This will require all filers to comply with the U.S. GAAP reconciliation requirements of Item 18 of Form 20-F where such reconciliation is otherwise required.
- Additional Form 20-F disclosure requirements. New disclosure requirements will be added to Form 20-F, including disclosure of disagreements with or changes in certifying accountants; fees, payments and other charges related to American Depositary Receipts; and significant differences in corporate governance practices as compared to U.S. issuers.
The proposed requirement to provide financial information in annual reports for acquired businesses significant at the 50 percent level was not adopted.
Technical amendments were also adopted to Exchange Act Rule 13e-3 regarding going-private transactions for consistency with the 2007 rule changes on foreign private issuer deregistration and termination of reporting requirements.
Rules governing cross-border tender and exchange offers, other business combinations and rights offerings were adopted by the Commission in 1999. The 1999 cross-border rules were designed to strike an appropriate balance between facilitating cross-border transactions and extending the protections of the U.S. securities laws to U.S. investors. Contrary to the SEC’s expectations, however, anecdotal evidence shows that foreign bidders have continued to exclude U.S. investors from tender and exchange offers wherever possible in order to avoid contact with U.S. regulation (and U.S. litigation). The rule changes adopted by the SEC on August 27, 2008, are intended to fine-tune the existing cross-border rules to increase the likelihood that U.S. investors will not be excluded from future transactions by making the existing tests and definitions under the rules easier to calculate and apply, eliminating anomalies that continued to exist among the rules relating to different transaction structures, and by codifying certain Staff interpretative positions that have been repeatedly issued since 1999, including those that apply to conflicts between the United States and foreign regulatory regimes, so as to minimize the need to seek no-action or exemptive relief for future transactions.
Calculation of U.S. Beneficial Ownership
Part of the changes relate to the calculation of beneficial ownership and the “look-through” rules. The SEC agreed to change the timing and reference date for the calculation of U.S. ownership. Under the amended rules, U.S. ownership may be calculated as of any date not more than 60 days before nor longer than 30 days after a public announcement of the transaction. If an acquirer or issuer is unable to calculate within this period, any date within 120 days prior to the announcement may be used. In addition, in an effort to significantly expand the number of transactions eligible for the exemptions while still providing appropriate U.S. investor protection, the SEC eliminated the current requirement to exclude from the U.S. ownership calculation securities held by holders of more than 10 percent of the subject securities. Target securities held by the acquirer or bidder, however, will continue to be excluded from the U.S. ownership calculation.
An alternative eligibility test will also be available for acquirers and issuers who are unable to conduct the modified look through rules discussed above. The alternative eligibility test is based upon average daily trading volume of the target securities in the United States compared to worldwide volume. The acquirer or issuer must also take into account reports of U.S. ownership filed with the home country regulator and in the primary trading market, as well as other beneficial ownership information it knows or has reason to know.
In addition, foreign institutions will be permitted under the new rules to utilize Schedule 13G to the same extent as their domestic counterparts. Corresponding changes will be made to the beneficial ownership rules under Section 16 of the Exchange Act.
Broadening of Tier I and Tier II Exemptions
The Tier I exemption will now include going-private transactions subject to Rule 13e-3. Tier II exemptions will now be available for unregistered tender offers. Further changes have been made to the rules affecting the conduct of Tier II transactions, including in relation to multiple foreign offers, withdrawal rights, subsequent offering periods and early termination.
Issuance of Guidance on Cross-Border Transactions
As part of the refinement of the cross-border rules, the SEC will issue interpretive guidance relating to the ability to reduce or waive a minimum acceptance condition without providing withdraw rights; the ability to exclude foreign target security holders in tender offers that are subject to U.S. equal treatment rules, or to exclude U.S. security holders without violating U.S. tender offer rules; and vendor placements.
Roadmap for Adoption of IFRS
In further action, the SEC adopted a proposed “roadmap” for the use by U.S. domestic issuers of IFRS (as adopted by the IASB) beginning in 2014, subject to certain milestones that must be achieved in the intervening period. The proposal would also allow a limited number of U.S. domestic issuers to begin using IFRS for their financial reporting in the near term on a test basis in order to allow the SEC to obtain valuable information on issues relating to conversion and comparability.
As a basis for moving towards IFRS, the SEC noted the quickening pace for adoption of a global single set of high quality financial reporting requirements. With consistency across markets, investors will find it easier to compare disclosures and weigh investment opportunities, and will have greater confidence in transparency. Currently, more than 100 countries permit the use of IFRS, including all countries in the European Union, although not all countries have adopted IFRS as adopted by the IASB.
Achievement of various milestones would be required as part of the ongoing consideration by the SEC of the adoption of a mandatory IFRS reporting requirement for U.S. issuers. These milestones relate to, among others, improvements in accounting standards; the accountability and funding of the International Accounting Standard Committee Foundation; improvement in the ability to use interactive data for IFRS reporting, e.g., XBRL; and education and training of investors, auditors and others in the United States on IFRS.
The SEC considers that the key principles to success will be in the development of accounting standards that are crafted in the interest of investors, with a standard-setting process that is transparent, and a standard-setting body that is independent.
Limited Early Use on Optional Basis
The SEC intends to identify categories of U.S. issuers where the use of IFRS would promote its ability to assess comparability in the near team. The eligible issuers will be limited to those that are in the top 20 by market cap of its industry globally. In addition, within the industry group, IFRS must be the most common basis for financial reporting among the top 20 companies. Interested issuers would be required to assess their eligibility and to obtain a “no objection” letter from the SEC prior to reporting in IFRS. Reconciliation to U.S. GAAP would be required, subject to two alternative proposals. The SEC anticipates that U.S. issuers in this optional phase would begin to report under IFRS in 2010 with respect to the financial year ended in 2009.
In 2011, the SEC would evaluate achievement of the milestones and make a decision as to whether to adopt a mandatory IFRS requirement. It is proposed that, if adopted, the mandatory requirement would be phased in based upon a company’s size and reporting status, such that large accelerated filers would begin to report under IFRS in 2014, accelerated filers in 2015 and non-accelerated filers in 2016.