Regulation of Foreign Securities in The US

There are essentially two methods by which foreign access to US securities are regulated in the US. One way is by virtue of the US public market and the other is by private offerings in the US by foreign issuers. (Greene, Rosen, Silverman, Braveman and Sperber, 2005) The initial Securities Exchange Act 1934 created the Securities and Exchange Commission to ensure that the provisions contained in the Securities Exchange Act 1934 and the Securities Act 1933 Act are complied with.

(Wigmore, 1985, 526) 20263) In all events, foreign securities brokers and dealers are required to register with the Securities Exchange Commission or to apply for an exemption in order to negotiate and trade with US investors in a manner analogous to the requirements set forth for US investors. The approach taken is one that emphasises oversight, disclosure and transparency. The regulatory process emanates from the Securities Act 1933, the Securities Exchange Act 1934 each of which have been amended several times since inception.

The purpose of this research is to examine the regulatory process, its development and evolution within the United States with respect to foreign securities. Literature Review Background Foreign securities are offered on the public market when they are offered publicly and their securities are listed for public trade in the US. (Hodgdon, Tondkar and Coffman, 2003, 133) Private offerings occur when foreign securities are offered directly to investors in the US. (Bastos, 2006, 66) Prior to the Great Depression, securities markets’ regulations were primarily regulated on a State to State basis.

However Federal regulations commenced in the 1930s after the markets collapsed “in the Great Depression. ” (Bartos, 2006, 1) What followed were a series of statutes enacted from 1933 to 1940, each predicated on a concept of full and frank disclosure. (Bartos, 2006, 2) Each of the statutes are “administered by the US Securities and Exchange Commission” which is: “... an independent regulatory agency operating under the Executive branch of the US Federal government. ” (Bartos, 2006, 2)

The Securities and Exchange Commission (SEC) is comprised of five president appointed commissioners whose mandate derives from the US Senate and are assisted by a team of attorneys, financial analysts, accountants and other similar professionals. (Bartos, 2006, 2) The various Securities Exchange Acts have been amended over the years and have conferred upon the SEC the authority to issue rules, regulations and “interpretive and enforcement” provisions, a number of which have been implemented since its establishment. (Bartos, 2006, 2)

The new regulatory framework followed from perceived lessons of past mistakes. From 1929 to 1932 the New York Stock Exchange had incurred a number of losses to the extent of approximately 83 percent of its value. (Bierman, 1991, 120) The consequences for financial institutions, companies, employment, savings and the stock market’s integrity were negative and the Great Depression that followed was a culmination of the losses accrued. (Wigmore, 1985, 3) Galbraith (1988) described Stock Market trading in the pre-Depression era as characteristic of “speculative euphoria.

”(8) This method of trading had been cultivated as a result of the relative prosperity that endured after World War I so much so that trade had become vastly unregulated and traders would partake of stock exchange with little or no data relying in large part on speculation and conjecture. (Galbraith, 1988, 66-87) Essentially there were no federal government mandated regulations with respect to securities’ trade on the securities’ markets and investors were not required to disclose information relating to the securities offered.

(Bierman, 1991) Investors were at liberty to rely on their own information and perceptions since there was no legal framework requiring disclosure. It was entirely a voluntary gesture and issuers could if they desired, disclose financial statements and other business related information that impacted the value of the offering. (Bierman, 1991) The financial chaos and the stock market collapse that ensued, prompted Congress to act.

What followed were implementation of the Securities Act 1933 and the Securities Exchange Act 1934 which had as their respective goals the revival of the stock market and the restoration of public and investor confidence. In a 1977 Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, the report identified four composite goals of the US securities legal framework. These goals are summarized as follows: • Protecting the public from “fraud and manipulation” and preserving the integrity of businesses.

(Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 1977, 557-558) • Involving the government in a limited way. • All significant information regarding “the issuance of securities” should be publicly disclosed. (Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 1977, 557-558) • Any person or entity “sponsoring the investment of other people’s money” should be accountable as would a trustee with fiduciary responsibilities.

(Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 1977, 557-558) Reflecting the goals listed by the Advisory Committee on Corporate Disclosure, the Securities Act 1933 mandated disclosure via two distinct methods. First, persons or entities making public offerings were required to register financial statements. Secondly, issuers were required to register the relevant prospectus. The registered statements would contain a list of the offerings’ liabilities as well as assets and any information that was related to the stocks in question.

The prospectus would disclose summaries of the statements. (Seligman, 2003, 1-38) The Securities Exchange Act 1934 functioned to extend the ambit of disclosure mandated by the Securities Act1933. It made provision for negotiations conducted by proxy to fall under the disclosure requirements within the 1933 Act. . (Seligman, 2003, 1-38) Moreover, proxy negotiations/solicitations were required to reflect shareholder voting with respect to board conduct and management.

. (Seligman, 2003, 1-38) In short, the Securities Exchange Act 1934 commanded the disclosure of stock conduct on the part of all members of the company offering public securities. . (Seligman, 2003, 1-38) The registration requirements of the Securities Act 1933 and the Securities Exchanbe act proved too onerous and series of de-listing ensued. A practice followed which was essentially characterized by “over-the-counter” trade in securities. (Plant, 1938, 98) This practice gave way to the Securities Exchange Amendment Act 1936. (Plant, 1938, 99)

The amended Act attempted to eliminate the risk of delisting providing exemptions and a means by which exemptions can be extended. A general exemption was allowed for dealers who had previously traded in securities before the implementation of the 1934 Act. The exemption would take the form of a waiver of most of the disclosure requirements contained under the both the 1933 and 1934 Acts. provided two means by which to discourage delisting. (Securities Exchange Amendment Act 1936) Section 78(1)(f) allowed an application for an extension as follows:

“No application to extend unlisted trading privileges to any security…shall be approved unless the applicant exchange shall establish to the satisfaction of the Commission that there exists in the vicinity of such exchange sufficiently widespread public distribution of such security and sufficient public trading activity therein to render the extension of unlisted trading privileges on such exchange thereto necessary or appropriate in the public interest or for the protection of investors. ” (Securities Exchange Amendment Act 1936, Section 78(1)(f))

By 1982, there have been at least 37 amendments to the Securities Act 1933 alone. (Mahoney, 2001, 1) Initially intended to protect and preserve US securities, the Act proved inadequate with respect to foreign securities issued in the US. Subsequent amendments set out the procedure for registration and ongoing reporting of foreign securities within the US. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 01) The Sarbanes-Oxley Act 2002 was one such amendment to the US Securities Exchange Act impacting the regulatory regime of foreign securities in the US.

(Marks, 2004) Regulation of Foreign Securities in the US i) The Securities Exchange Act 1934 as Amended There are two primary methods by which the US regulate foreign securities issued in the US. One method is by registration and the other is by virtue of “on-going reporting” each of which originate from the Securities Exchange Act 1934 as amended over the years. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 01) All reporting companies subject to the Exchange Act 1934 are also required to manage and sustaing a satisfactory internal control system.

There are also constraints on the company’s ability to repurchase securities. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 01) Section 12(a) and (b) of the Securities Exchange Act applies to both foreign and issuers who have securities that are listed with either the US Securities Exchange of quoted by Nasdaq. (Securities Exchange Act 1934 as Amended, Section 12 (a) and (b)) Securities so listed and quoted are required to be registered under the Securities Exchange Act.

.(Securities Exchange Act 1934 as Amended, Section 12 (a) and (b)) Registration is required regardless of whether or not there is a public offering within the US. It therefore follows that a foreign issuer: “wishing to diversify its shareholder base by listing its outstanding common stock on the NYSE or Nasdaq must register that class under the Exchange Act. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) The requirements for registration relate to both equity and debt. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02.

2) In all cased registration is required prior to trading and is coordinated by virtue of approval by the relevant exchange board and for public offerings within the US under the Securities Act 1933. One month following the registration of a statement under the Exchange Act, it becomes effective but can be shortened provided there are no disclosure issues. (Securities Act 1934 as Amended, Section 12(d)) Issuers meeting certain shareholder and capital sizes may also be required to register regardless of whether they are issuers or potential issuers under the Nasdaq quotation mandate of the exchange listing.

(Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) By virtue of Section 12(g) and Rule 12g-l and 12g3-2(a) all foreign issuers are required to register all classes of securities in equity if it holds at least 500 individuals on a global level or at least 300 within the US. (Securities Exchange Act 1934 as Amended Section 12(g) and Rule 12g-l and 12g3-2(a)) However, exemptions are possible if the foreign issuer qualifies and makes an application within a certain timeframe. (Securities Exchange Act 1934 as Amended, Rule 12g 3-2b) Exemption is possible in the case of a foreign issuer who has:

“... sponsored an American Depositary Receipt (ADR) program with respect to its outstanding shares but has not obtained a US Exchange listing or Nasdaq quotation. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) In other words if a foreign issuer has at least 300 holders of securities in the US or has maintained a record of 500 persons or more and meets the asset test under the ADR, the issuer can either claim exemption or register that particular class of securities under the Securities Exchange Act 1934 as amended, under Rule 12g3-2(b).

In order to be approved for exemption the foreign issuer is required to make an application to the Securities Exchange Commission. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) In the event the foreign issuer fails to make an application for exemption he/she is required to register by filing a registration statement under the Securities Exchange Act 1934 as amended. The filing must take place within 120 days following the end of the fiscal year “in which it exceeded the thresholds for assets and numbers of shareholders. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3.

02. 2) The assets threshold is 10 million dollars or more. (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) Registration and exemption for foreign issuers are only available to foreign issuers if they do not have or have not previously had for the last 18 months: • Securities either listed with the US Securities Exchange or quoted by Nasdaq or registered by virtue of Section 12 (g). • Or is under an intermittent reporting requirement whether active or not under the Securities Exchange Act relating to previous public offerings within the US.

(Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 2) Rule 12g3-2(b) requires that foreign companies seeking to issue securities in the US and seeking registration and/or exemption are required to provide to the Securities Exchange Commission information that: • The company would otherwise make public under the laws of its own jurisdiction. • Files pertaining to stock exchange reflecting the company’s trade in securities or; • Those securities distributed to the company’s security holders. (Securities Exchange Act 1934 as Amended, Rule 12g3-2(b))

Although the company is not obligated to provide all aspects of the information listed above, it is under a residual duty to provide all information that is relevant for the purposes of making an “investment decision. ” (Securities Exchange Act 1934 as Amended, Rule 12g3-2(b)) This information required to be provided must date back to the “beginning of the company’s last fiscal year” and must be provided upon the “initial submission” with “subsequent information made available to the Securities Exchange Commission corresponding with its actual release.

” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 10) The foreign company is also required to provide the Securities Exchange Commission with information detailing the number of US residents holding equity securities, the interest held by them as well as “the circumstances in which US resident acquired such securities. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 10) In any event, as Greene et ales (2005) notes: “...

the requirement to register under the Exchange Act (if the exemption is not claimed) is clear and is consistent with the SEC’s general philosophy that its mandate is to assure US investors information in the United States about their investments. ” (para 3. 02. 3) Successor issuers of foreign companies registered under Section 12 of the Amended 1934 Act will automatically be deemed registered. (Securities Exchange Act 1934 as Amended Rule 12g-3) Succession is possible by virtue of merger, acquisition, consolidation, exchange of securities or in like fashion.

(Securities Exchange Act 1934 as Amended Rule 12g-3) However, a foreign successor issue meeting this stipulation may nevertheless not accorded automatic registration status if at the time of the succession: • The particular securities “issued by the successor issuer is exempt from Exchange Act registration requirements other than by Rule 12g3-2. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 3) • The securities held are held by less than 300 persons globally, or • The “successor issuer is a Canadian corporation meeting” specific requirements.

(Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 3) In the event any one of the above listed exceptions apply the successor issuer is required to file its annual report “on behalf of the acquired company” reflecting that company’s fiscal year for the last year prior to succession and is required to contain: “information that would have been required if filed by the acquired company, unless that annual report has already been filed. ” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 02. 3)

Additionally the successor issuer is required to file with the Securities Exchange Commission its annual reports relating to its business reflecting “each fiscal year beginning on or after the date of which the succession occurred. ” (Securities Act 1934 as Amended, Rule 12g-3(g)) ii) The Sarbanes-Oxley Act 2002 In general, subject to some limited exceptions the Sarbanes-Oxley Act 2002 applies to all securities issuers. Issuers are companies as follows: • With registered securities under Section 12 of the Securities Exchange Act. • That have a statutory obligation to file reports under the Securities Exchange Act; or

• That file or have previously filed a statement under the Securities Act that is still ineffective but has not been withdrawn. (Sarbanes-Oxley Act 2002) Greene et ales (2005) explain that the implications of the Sarbanes-Oxley Act is that it now extends the reach of the Securities Exchange Commission to all issuers, foreign and domestic, public and private. (Para 3. 07. 1) However the Securities Exchange Commission: “has used its specific exemptive power in certain cases to provide some relief to foreign private issuers in the rulemaking process.

” (Greene, Rosen, Silverman, Braveman and Sperber, 2005, Para 3. 07. 1) Section 302 of the Sarbanes-Oxley Act 2002 has been incorporated into Rules 13-14 and 15d-14 of the Exchange Act 1934 and require that the executives and principles of an entity certify the issuer’s annual reports contained in Form 20-F, (the form required for registration or exemption). (Sarbanes-Oxley Act 2002, Section 302). The certification is required to contain reflect that: • The certifying representative has looked over the report. • To the certifier’s knowledge and information the report is accurate.

• To the certifier’s knowledge and information the financial statements together with all of its supporting information is a fair representation of the issuer’s financial status, operational results and income for the periods stipulated in the report. • The certifier has the responsibility of setting up and managing disclosure with respect to the issuer and can certify that: 1) The disclosure management and control mechanisms are conducted in a satisfactory manner. 2) The certifier has examined the issuer’s disclosure mechanisms and that they are consistent with the control mechanisms mandated by the certifier.

3) Any departure from protocol is reflected in the report. 4) All defects in the disclosure mechanisms have been duly reported. (Sarbanes-Oxley Act 2002, Section 302) Section 906 of the Sarbanes-Oxley Act 2002 requires the issuer’s principles to file intermittent certifications in respect to all financial statements filed by the issuer. (Sarbanes-Oxley Act 2002 Section 906) The certification is required to reflect the fact that the principle has inspected the statement and is satisfied that it complies with the provisions of the Securities Act and that it is a fair representation of the information it contains.

(Sarbanes-Oxley Act 2002, Section 906) Section 301 of the Sarbanes-Oxley Act 2002 also requires that foreign issuers and all issuers seeking registration with the Securities Exchange Commission subscribe to an audit committee and comply with the audit committee’s mandate. (Sarbanes-Oxley Act 2002, Section 301) The Securities Exchange Commission implemented the mandate of Section 301 of the Sarbanes-Oxley Act by adopting Rule 10A-3 and it only applies to issuers whose securities are listed on the US securities exchange or are quoted on Nasdaq. Rule 10A-3 requires that:

• The issuer’s audit committee is neutral and independent. • The audit committee is required to accept responsibility for the supervision and appointment of the neutral and independent auditor. • The audit committee is required to respond to the issuer’s concerns with respect to internal account management, auditing and like issues. • The audit committee is at liberty to retain independent attorneys and other professional help where appropriate. • The issuer is required to fund the cost of outside advice and the independent auditor. (Securities Exchange Act 1934 as Amended Rule 10A-3)

Discussion The cumulative impact of the Securities Exchange Act and each of its subsequent amendments, particularly the Sarbanes-Oxley Act reflect the age-old goals of the Securities Exchange commission. That goal is to protect US investors by creating a securities’ market that is rigid and transparent. Tafara and Peterson (2007) argue however, that with today’s increasing global markets and the ease with which global markets are facilitated by technological advancements, the current registration requirements for foreign issuers is no longer desirable.

Tafara and Peterson (2007) point out that: “Our markets are now interconnected and viewing them in isolation – as we have for so long – is no longer the best approach to protecting our investors, promoting an efficient and transparent US market, or facilitating capital formation for US issuers. ” (32) In particular the practice of requiring foreign issuers who provide a service that is not typically available in the US should have special consideration. (Tafara and Peterson 2007, 32) Those foreign issuers should not be required to register with the Securities Exchange Commission.

Instead they ought to be permitted to subscribe to a “system of substituted compliance with the SEC regulations. ” (Tafara and Peterson 2007, 32) Rather than require that these foreign dealers comply with the regulatory framework of the Federal Government and the Securities Exchange Commission it should be sufficient for them to achieve exemption or registration within the US if it can be shown that they comply with: “... substantively comparable foreign securities regulations and laws and supervision by a foreign securities regulator with oversight powers and a regulator and enforcement philosophy substantively similar to the SEC’s.

” (Tafara and Peterson 2007, 32) The Securities Exchange Commission would still retain jurisdiction over these foreign securities offered in the US in the event there are issues of fraud. (Tafara and Peterson 2007, 32) The suggestion put forth by Tafara and Peterson (2007) makes sense in light of the fact that in recent years world markets have become increasingly global and improvements in information technology have made globalization of capital markets a simple exercise.

(Coffee, 2002, 1759) Even so, there has to be a balance particularly since financial scandals such as the Enron scandal in 2001 have only reawakened the fears that abounded following the Great Depression era. Tafara and Peterson (2007) explain however, how improvements in information technology command an improved regulatory regime with respect to the US position on foreign Securities. Tafar and Peterson explain that:

“Not so long ago a major financial firm might employ a bank of telephones to conduct just a single cross-border transaction, today an entire stock exchange, regardless of where it is located in the world, can be accessed via trading screens located in any number of broker-dealers’ offices. ” (Tafara and Peterson, 2007, 33-34) Another striking feature of today’s securities exchange is that investors are increasingly looking to foreign markets for financial gain. (Tafara and Peterson, 2007, 34) This trend is quite prevalent in the New York Stock Exchange (NYSE) which is the world’s largest stock market.

(Tafara and Peterson, 2007, 34) Even so, for most of its existence the NYSE has remained predominantly a domestic forum. The following facts are note-worthy: • 1975 – there were only 33 foreign companies listed with the NYSE representing only 2. 12 percent of the 557 listing. • 1990 – The number increased to 96 representing 5. 4 percent of the NYSE’s total listings. • 2007 – 450 foreign companies are listed with the NYSE. The total number is 2672 therefore the percentage of foreign company securities listed with the NYSE in 2007 is 16. 9. Their combined market value is US$7.

9 trillion out of the NYSE’s total securities listing of US21. 2 trillion. (Tafara and Peterson, 2007, 34) While information technology has made it easier to trade on the stock market, it has also facilitated the incidents of fraud. Tafara and Peterson (2007) observe that: “It is well recognized that the technology that allows for cross-border markets also allows for cross-border fraud. ” (35) To this end any changes in the registration and exemption mandate with respect to foreign securities within the US is required to take the risk of the incidents of fraud into account.

Therefore the regulatory regime cannot abandon its approach to transparency. However, it can relax the tenacity with which it sets standards for foreign investors by allowing these issuers to comply with their own country’s regulatory framework, provided it is similar, at least in principle to that of the US. The incidents of fraud that threaten the securities exchange can be effectively circumvented by such a system of self-imposed harmonization. There is no doubt that the 1929 stock market crash was attributed in large part to fraud which was a result of poor regulation of the US stock markets.

(Tafara and Peterson, 2007, 37) The scandals that have erupted in the 21st century, in the United States and abroad, suggests that fraud remains a serious threat to securities’ trade stability. Stock market scandals have been attributed to Enron and WorldCom in the US. (Tafara and Peterson, 2007, 37) Other scandals around the world include Parmalat in Italy, Ahold in The Netherlands, Royal Dutch Shell in the UK and The Netherlands, Vivendi in France, Hollinger in Canada, Livedoor in Japan and TV Azteca in Mexico. (Tafara and Peterson, 2007, 34) These cases reflect how vulnerable the stock exchange markets around the world have become.