Originally published as an International Capital Markets eUpdate

The US Securities and Exchange Commission (the SEC) has been busy amending rules and pushing forward initiatives that in general favor the interests of non-US issuers, banks and other market actors seeking to participate in the US capital markets. Below, we report on key changes that have taken effect or that have developed significantly during the first half of 2008, including:

  • in certain circumstances, permitting non-US issuers to use IFRS rather than US GAAP to prepare their financial statements for public filing in the US;
  • shortening the holding periods that curtail resales of “restricted securities”, and making other changes to reduce compliance burdens under SEC Rules 144 and 145; and
  • amending the definition of “foreign private issuer” and other provisions regulating non-US issuers, including Rule 12g3-2(b), which exempts certain non-US issuers from obligations to report publicly in the US.

Financial Statements Without US GAAP Reconciliation

The SEC has adopted rule changes that allow foreign private issuers (FPIs) (defined to include, generally, non-US companies in which US residents hold less than a majority of the equity, or whose directors and officers, business administration and assets are mostly outside the US) that are or become public in the US to include in their SEC filings financial statements that are prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (the IASB), without reconciliation to US generally accepted accounting principles (US GAAP). Prior to these changes, all issuers of securities to the public in the US, whether US entities or non-US entities, had to either prepare the financial statements in their US disclosure documents under US GAAP or “reconcile” the non-US GAAP financial statements to US GAAP.

These changes represent the beginning of the end of a major impediment to many FPIs contemplating a public offering in the US. Previously, the burdens of cost and time involved in preparing US GAAP accounts or a US GAAP reconciliation, in addition to preparing home-GAAP accounts in the normal course, have led many FPIs to decide against going public in the US. The SEC's changes should remove these obstacles for many FPIs. In addition, they should facilitate acquisitions by FPIs of US public companies. Moreover, this may be the beginning of the end of US GAAP. Already, SEC personnel are speaking publicly about moving to a rules regime in which even US companies can report publicly under IFRS, rather than US GAAP.

The rule changes took effect on March 4, 2008, and apply generally for financial years ending after November 15, 2007, as well as for interim periods within those years that are covered by filings made after the effective date of the changes. Foreign private issuers using IFRS other than as issued by the IASB, or using other non-US accounting principles, will continue to be subject to the US GAAP reconciliation requirement. A limited accommodation has been made for SEC-registered European Union FPIs that have historically prepared financial statements by applying the EU’s carve-out from IAS 39 with respect to hedge accounting for certain financial instruments. For those issuers’ first two financial years that end after November 15, 2007, the SEC will accept filings that do not include US GAAP financial statements or a reconciliation to US GAAP if the financial statements that are included otherwise comply with, and include a reconciliation to, IFRS as issued by the IASB.

Amendments to Rule 144

SEC Rule 144 defines as “restricted securities” most securities sold privately rather than pursuant to SEC registration, and specifies certain requirements for the limited resale of such securities until certain holding periods expire. Rule 144 also prescribes limits on the resale of an issuer’s securities by “affiliates” of the issuer (including, typically, persons sitting on the issuer’s board, holding 10% or more of the issuer’s equity or otherwise exercising control over the issuer).

The SEC has amended Rule 144 to reduce the period during which restricted securities and affiliate-held securities are completely ineligible for resale (absent the availability of another exemption from SEC registration) from one year to six months, if the issuer of the securities (whether a US company or a non-US company) is already a public reporting company in the US. The one-year “no resales” period has been retained if the issuer of the securities (whether a US company or a non-US company) is not a public reporting company in the US.

The old Rule 144 provisions under which resales of restricted securities had been further limited for another year after the end of the initial holding period (including the requirement that such securities could only be “dribbled out” under specified volume-of-sale restrictions during that second year) have been eliminated, with one exception: holders of restricted securities of issuers that are public in the US may only resell their securities during the six months following the initial six-month holding period if certain specified “current information” concerning the issuer is publicly available. In contrast, most of the old Rule 144 limiting provisions for affiliate-held securities have been retained (for example, affiliate holders must follow the “current information” requirement, can only “dribble out” securities pursuant to volume-of-sale restrictions and manner-of-sale limitations, and in certain circumstances must notify the SEC of their resales by filing a Form 144), although a few of these restrictions have been streamlined and simplified.

Shortening the Rule 144 holding periods for restricted securities when the issuer is public in the US, and doing away with all Rule 144 restrictions for non-affiliates that wish to resell restricted securities after one year, should increase the attractiveness and liquidity of securities placed privately in the US, and therefore decrease the cost of raising capital privately in the US, whether the issuer is a US company or a non-US company. The Rule 144 changes became effective as of February 15, 2008.

Amendments to Rule 145

SEC Rule 145 characterizes the exchange of securities effected in connection with certain business combinations as the offering of securities, in order to extend to investors subject to the exchange the protections of the US Securities Act. As a result, such exchanges must either be registered with the SEC by the securities issuer or conducted pursuant to exemptions from registration.

Previously under Rule 145, parties to the exchange transaction (other than the securities issuer) and affiliates of those parties were deemed to be underwriters and were therefore subject to potential underwriter liability and other restrictions and requirements. The SEC has now amended Rule 145 to eliminate this provision for most parties. However, parties to an exchange transaction (other than the securities issuer) involving a shell company (other than a business combination-related shell company) and affiliates of those parties continue to be characterized as underwriters. Under the amended Rule 145, parties deemed to be underwriters may only resell their securities if (i) at least 90 days have elapsed since the securities were acquired in an exchange transaction and certain provisions of Rule 144 are met; (ii) at least six months have elapsed since the securities were acquired in an exchange transaction, the current public information condition under Rule 144 has been met and the sellers are not affiliates of the issuer at the time of the sale and have not been affiliates during the three months before the sale; or (iii) at least one year has elapsed since the securities were acquired in an exchange transaction and the sellers are not affiliates of the issuer at the time of sale and have not been affiliates during the three months before the sale. The Rule 145 changes became effective as of February 15, 2008.

Proposed Changes to Foreign Private Issuer Definition and Rules

Not all recent news from the SEC has been good for non-US issuers. In particular, the SEC has proposed changes to the definition of “foreign private issuer”, and to certain rules governing non-US issuers that qualify as such issuers, which may create problems for those issuers. Happily, public commentary on the proposed changes has focused on these problems, and the SEC has since been taking its time in proceeding with the changes. The end result may be re-proposed or final rules that are helpful to, rather than harmful for, non-US issuers.

Key portions of the original proposals would: 

  • allow companies to re-assess their status as FPIs only once a year, rather than continuously;
  • require the disclosure of a number of new, smaller information items in FPIs’ reports on Form 20-F, which they must file annually with the SEC, and remove an option that currently allows FPIs to omit segment data from financial disclosures;
  • require FPIs that qualify as accelerated filers (issuers with a public float of US$75 million or more) to file their annual reports on Form 20-F within 90 days of their fiscal year-end, and all other FPIs to file their 20-F reports within 120 days of their fiscal year-end, instead of the currently allowed six-month period; and
  • change the manner of calculating the US shareholding in an FPI for purposes of Rule 12g3-2(b). Pursuant to that rule, if an FPI has less than a specified maximum US shareholding, it can avoid obligations to report publicly in the US.

It is the last two proposed changes that have generated criticism and concerns.

If the first of these criticized changes is adopted, it would in many cases require FPIs to file their principal annual disclosure packages in the US before they must file them in their home jurisdictions. For example, the majority of European Union member states have adopted the EU’s Transparency Directive, which mandates publication of an annual report within four months of year-end, not 90 or 120 days. FPIs that prepare home country filings in languages other than English would face additional time pressures. These concerns are particularly relevant given the SEC's history of imposing material penalties for late filings, including removing an issuer's eligibility to use accelerated procedures when issuing new securities.

If the second of these criticized changes is adopted, the utility of Rule 12g3-2(b) may be so reduced that FPIs that might otherwise conduct private securities offerings in the US or establish American Depositary Receipt (ADR) programs in the US may avoid doing so in the future.

Currently, Rule 12g3-2(b) exempts an FPI from having to make substantial aftermarket disclosures in the US, including filing annual reports on Form 20-F with the SEC, if the FPI applies for the 12g3-2(b) exemption with the SEC and at the time of its application has had less than 300 US-resident shareholders at the end of its last fiscal year, and if it thereafter submits copies of its home-jurisdiction public disclosures to the SEC on a regular basis. Once obtained, the exemption is permanent, so long as the issuer continues to timely copy the SEC on its home-jurisdiction disclosures and does not undertake an offering or listing of securities requiring Securities Act registration.

Under the proposed changes to the rule, the FPI could claim the exemption without having to submit an application to the SEC, but it could maintain the exemption only so long as the average daily trading volume of its relevant class of securities in the US during its most recently completed fiscal year is no greater than 20% of the average daily trading volume of that class of securities on a worldwide basis for the same period.

It is the shift from an effectively permanent exemption to an impermanent exemption that most worries critics of the proposed changes. Aftermarket reporting on a public basis in the US is burdensome and expensive. If an obligation to so report could arise for any FPI following any year in which US trading in its securities spiked upwards, a rational response for FPIs that wish to avoid the risk of such reporting would be to keep their securities out of the US markets to the extent possible. This would certainly include avoiding private offerings into the US and the establishment of ADR programs, which would be a setback for the US capital markets.

We will comment further if and when the SEC next takes steps in respect of its proposed new FPI filing deadlines and its proposed changes to Rule 12g3-2(b). We remain hopeful that the SEC's current pause in the process of implementing these rule changes means that the regulators are re-thinking the problem issues.