On December 22, 2006, the SEC reproposed rule amendments that are intended to ease current restrictions on the ability of foreign private issuers to terminate registration of their securities under the Securities Exchange Act of 1934 and cease filing reports with the SEC. This rulemaking represents one of the SEC’s continuing initiatives to revamp provisions in its rules that have discouraged foreign companies from entering the U.S. public capital markets. We discussed in our SEC Update of January 12, 2006 the deregistration rule amendments originally proposed by the SEC in December 2005. The SEC reconsidered its original rule proposal after commenters expressed concern that the new rules would not have afforded measurable relief to a significant portion of U.S.-registered foreign private issuers. The reproposed amendments address this concern in a number of ways, most notably by affording all foreign private issuers a benchmark for deregistration based on the trading volume of their securities in the United States rather than on the number of their U.S. security holders. The revised proposals would not change the rules that govern Exchange Act deregistration or termination of reporting obligations by U.S. issuers. The reproposed rules are described in Release No. 34-55005 and are open for public comment until February 12, 2007.
A foreign private issuer is a non-U.S. company that either has 50% or less of its outstanding voting securities held of record by U.S. residents or that has more than 50% of its outstanding voting securities held by U.S. residents and has no other specified nexus with the United States. Under current SEC rules, a foreign private issuer’s ability to terminate its reporting obligations under Section 13(a) of the Exchange Act depends on the manner in which it became subject to those obligations. A foreign private issuer may become subject to Section 13(a) reporting if it:
- registers a class of equity or debt securities under Section 12(b) of the Exchange Act in connection with its listing of that class on a U.S. national securities exchange;
- registers a class of equity securities under Section 12(g) of the Exchange Act because, at the end of any fiscal year, it has total assets of over $10 million and 300 or more holders of the class resident in the United States; or makes a registered offering of equity or debt securities in the United States and thereby becomes subject to Section 15(d) of the Exchange Act.
The issuer may incur reporting obligations under more than one of these Exchange Act sections, although only one such set of obligations will be active at any time. Accordingly, if a foreign private issuer seeks to terminate its Exchange Act reporting obligations, it must not only terminate any U.S. listing on a national securities exchange, but also must ensure that upon such a termination it has fewer than 300 U.S. resident security holders. As discussed in our prior SEC Update, a foreign private issuer may find it difficult under current rules to terminate its Exchange Act registration and reporting obligations despite the fact that there is relatively little interest in the issuer’s U.S.- registered securities among U.S. investors. Moreover, a foreign private issuer currently may only suspend, rather than terminate, a duty to report arising under Section 15(d) of the Exchange Act.
Reproposed Rule Amendments
The SEC has reproposed a new Rule 12h-6 under the Exchange Act and amendments to its existing rules to address the difficulties foreign private issuers currently confront in terminating their Exchange Act registration and reporting obligations. The rule changes would (1) eliminate provisions that primarily condition a foreign private issuer’s eligibility to terminate its Section 12(g) registration on whether the issuer has fewer than 300 U.S. resident security holders and (2) allow termination, rather than suspension only, of the issuer’s Section 15(d) reporting obligations. Reproposed Rule 12h-6 would permit a foreign private issuer to terminate its Section 12(g) registration and terminate SEC reporting based on Sections 12(g) and 15(d) regarding a class of equity securities for which U.S. investor interest is small relative to non-U.S. investor interest and where there is a low expected risk that termination of registration and reporting will harm U.S. investors. The reproposed rule also would allow a foreign private issuer to terminate its Section 15(d) reporting obligations regarding a class of debt securities once it has met the minimum Section 15(d) reporting requirement.
Conditions for Issuers of Equity Securities. In fashioning its new rule proposal, the SEC changed course on a number of important issues that will determine when and how a foreign private issuer with a registered class of equity securities may exit the Exchange Act reporting regime.
Measuring U.S. Market Interest in the Issuer’s Securities. The governing principle of the SEC’s deregistration rules is that a foreign private issuer should be allowed to terminate its Exchange Act obligations when U.S. investors have relatively little interest in the issuer’s U.S.-registered securities. The SEC has now proposed that all foreign private issuers, irrespective of size, may deregister a class of equity securities under reproposed Rule 12h-6 if the average trading volume of their securities in the United States is no greater than 5% of the average trading volume in the securities in the issuer’s primary trading market over a recent 12-month period. This exit standard will enable a foreign private issuer to terminate its Exchange Act obligations regardless of the number of its U.S. resident security holders. The original proposal would have required large foreign private issuers that qualify as “well-known seasoned issuers” (or WKSIs) to compare their U.S. “public float” (the portion of their U.S.-registered equity securities held by non-affiliates) with their worldwide public float or, alternatively, to determine that their U.S. resident holders hold no more than 5% of their worldwide public float. Smaller foreign private issuers would have been required to meet either the 5% U.S. resident ownership test or to determine that their registered securities were held by fewer than 300 persons on a worldwide basis or by fewer than 300 U.S. residents.
Commenters on the initial proposal convinced the SEC that the original deregistration benchmarks would have benefited too few existing reporting foreign private issuers and, accordingly, would not have advanced the SEC’s goal of encouraging other foreign companies to register their securities with the SEC. Commenters also pointed to the significant practical difficulties issuers would encounter in obtaining reliable information to compute their U.S. public float or the number of their U.S. security holders under the initially proposed benchmarks. The SEC concluded that a benchmark based solely on trading volume would provide the necessary direct measure of U.S. market interest in a foreign private issuer’s equity securities without subjecting issuers to the uncertainty and expense entailed in data collection under the other two standards. In abandoning different deregistration benchmarks based on company size, the SEC acknowledged that smaller foreign private issuers should benefit from the full range of deregistration options afforded to foreign WKSIs, since smaller companies bear a disproportionately heavier burden of Exchange Act reporting costs.
The SEC expressed concern in the reproposing release about the possibility that its proposed new approach might create an incentive for a foreign private issuer to decrease its U.S. trading volume in order to delist its securities from a U.S. exchange, particularly in cases where the issuer had a relatively active U.S. market for its securities before the delisting. Reproposed Rule 12h-6 would seek to deter an issuer from excluding U.S. investors from investing in its securities when U.S. market interest in the securities is still significant. It would require an issuer that has either delisted a class of equity securities from a U.S. exchange or terminated a sponsored American Depositary Receipt (ADR) facility at a time when the U.S. average daily trading volume of its securities exceeded 5% of its primary trading market volume to wait at least 12 months before terminating its Section 12(g) registration or Section 15(d) reporting obligations on the basis of the trading volume benchmark.
Additional Accommodations for Foreign Private Issuers. The new rule proposal reflects a more flexible regulatory approach than the previous proposal to deregistration conditions that are intended to protect U.S. investors when a foreign private issuer seeks to terminate its Exchange Act registration of a class of equity securities.
- Shorter Minimum Exchange Act Reporting Period. One of the Rule 12h-6 conditions would require a foreign private issuer to file reports under the Exchange Act for a minimum specified period before it may terminate its reporting obligations with respect to a class of equity securities. To be eligible for deregistration under the reproposed rule, a foreign private issuer must have (1) had reporting obligations under Section 13(a) or Section 15(d) of the Exchange Act for at least the 12 months before it files for deregistration on a new Form 15F, (2) filed or furnished all reports (including all Form 6-K reports) required for this period, and (3) filed at least one annual report pursuant to Section 13(a) of the Exchange Act. The SEC substituted a 12-month minimum reporting period for the two-year period originally proposed primarily because the shorter period is more in line with minimum reporting obligations of foreign private issuers under the current rules. Rule 12h-6 would contain a condition precluding a foreign private issuer from deregistering a class of equity securities shortly after it has conducted a capital-raising transaction in the United States involving sales of the registered securities. This prohibition would remain in effect for a oneyear “dormancy” period. As originally proposed, the dormancy period condition would have extended not only to sales pursuant to most offerings registered under the Securities Act, but also to sales in a wide range of unregistered offerings. In reproposing Rule 12h-6, the SEC has agreed to except from the dormancy condition sales in private offerings pursuant to Section 4(2), Regulation D and Rule 144A under the Securities Act, rights offerings exempt under Securities Act Rule 801, and exchange offers exempt under Securities Act Rule 802, as well as sales of exempt securities under Section 3 of the Securities Act, including sales pursuant to plans or arrangements exempted under Section 3(a)(10). In liberalizing the application of this condition, the SEC noted that it had been persuaded by commenters that, by prohibiting unregistered offerings, the new rule could cause foreign private issuers seeking deregistration to pursue private placement financings and other unregistered offerings outside the United States, to the detriment of U.S. investors and U.S. broker-dealers. In reproposing the dormancy condition, the SEC also expanded the types of registered offerings that are excluded from the condition’s prohibition against the sale of registered securities. In addition to permitting sales of registered securities to the issuer’s employees or by selling shareholders in a non-underwritten offering, the new rule would permit the company to issue registered securities upon the exercise of outstanding rights that have been granted pro rata to all security holders, pursuant to a dividend or interest reinvestment plan, or upon the conversion of outstanding convertible securities.
- Expanded Range of U.S. Equity Offerings During “Dormancy” Period.
- More Flexible Foreign Listing Condition. Rule 12h-6 contemplates that, before a foreign private issuer may terminate its Exchange Act reporting obligations, it must be subject to a disclosure and financial reporting regime, and have a significant market following, in its home market. This listing condition would increase the likelihood that non-U.S. securities disclosure documents would be available to U.S. investors when they make investment decisions about the issuer’s securities following the termination of its Exchange Act reporting obligations.
As reproposed, the new rule would implement the foreign listing condition by requiring that, for at least 12 months before it files to deregister a class of equity securities, a foreign private issuer must have maintained a listing of that class of securities on an exchange in a foreign jurisdiction which, either singly or together with one other foreign jurisdiction, constitutes the primary trading market for that class of securities. For purposes of defining “primary trading market,” the proposed rule would require that at least 55% of the trading in the foreign private issuer’s class of securities have taken place in, on or through the facilities of, a securities market or markets in no more than two foreign jurisdictions during a recent 12-month period. In response to comments on the original proposal, and consistent with the SEC’s proposed change to the prior reporting condition, the SEC has reduced the reproposed foreign listing period to one year from the originally proposed two years. The proposed revisions also would provide additional flexibility for some foreign private issuers by permitting an issuer to aggregate its trading over two non-U.S. markets for the purpose of meeting the foreign listing condition, as well as by proposing a “foreign listing” condition rather than a “home country” listing condition to accommodate issuers having their primary trading market in jurisdictions other than their place of incorporation or principal listing.
Other Proposed Changes. The new proposal also introduces a number of technical refinements to the proposed new rules. Among other changes, it would expand the scope of Rule 12h-6 to encompass successor issuers and issuers that already have filed under the current rules to effect the termination of their Exchange Act registration or reporting obligations.
Reproposed Rule 12h-6 would allow successor foreign private issuers, which are companies that have succeeded to another company’s Exchange Act registration and reporting obligations pursuant to Rule 12g-3 though a merger, consolidation, exchange of securities, or certain other transactions, to rely on the acquired company’s Exchange Act reporting history for purposes of Rule 12h-6. This change would potentially allow the successor issuer to qualify immediately for termination of its Exchange Act obligations without having to file an Exchange Act annual report, so long as it meets the other requirements of Rule 12h-6. In addition, the benefits of the reproposed rule, once effective, would extend to issuers that previously have filed for deregistration on current Form 15. These issuers would then be able to terminate their suspended Section 15(d) reporting obligations if they file the new Form 15F with the SEC and comply with other requirements of the new rule.
The regulatory barriers encountered by foreign private issuers in connection with deregistration under the Exchange Act and termination of their related reporting obligations have provoked vigorous criticism by representatives of foreign companies and foreign industry associations. These representatives have argued that the current deregistration regime, together with other aspects of U.S. securities law compliance, have had a chilling effect on the willingness of foreign companies to list securities in the U.S. markets or to engage in registered offerings in the United States. In both its December 2005 proposing release and the December 2006 reproposing release, the SEC expressly acknowledged that current rules operate as a disincentive to foreign private issuers accessing the U.S. public capital markets. The reproposed rule amendments represent a significant rethinking by the SEC of the appropriate balance between a foreign private issuer’s desire to exit U.S. reporting if there is relatively little U.S. market interest in its securities and the interests of U.S. investors in obtaining timely access to information about the issuer and its securities.