Assessment date for many foreign private issuers is quickly approaching on Monday, June 30,2014
A critical annual exercise for a foreign company that is a foreign private issuer and that does not voluntarily comply with the domestic reporting obligations of the Securities and Exchange Commission (the “SEC”) is the determination of its continued qualification as a foreign private issuer. A company’s status as a foreign private issuer is required to be reassessed on an annual basis as of the last business day of its second fiscal quarter, which for companies operating on a calendar year basis is Monday, June 30, 2014.1 If a company no longer meets the criteria for qualifying as a foreign private issuer, it must transition to the more stringent SEC reporting obligations that are applicable to domestic issuers beginning on the first day of the company’s next fiscal year, at which time it would no longer be able to avail itself of the benefits associated with being a foreign private issuer.2
Testing Continuing Eligibility
A “foreign private issuer” is any company organized under the laws of a jurisdiction outside of the United States unless it has both a high level of U.S. share ownership (triggered if more than 50% of its outstanding voting securities are held by U.S. residents) and business contacts in the United States (triggered if either (a) the majority of its executive officers or directors are U.S. citizens or residents, (b) more than 50% of its assets are located in the United States, or (c) its business is administered principally in the United States).
If 50% or less of a foreign company’s outstanding voting securities are directly or indirectly owned by U.S. residents as of the last business day of its second fiscal quarter, the company qualifies as a foreign private issuer and no further analysis is required. If, however, more than 50% of a foreign company’s outstanding voting securities are owned by U.S. residents, the company must look to the U.S. business contacts to further analyze its foreign private issuer status. The determination of share ownership is based on the methodology in Rule 12g3-2(a) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which uses the definition of “held of record” in Exchange Act Section 12g5-1 but requires companies to apply a “look through” approach to achieve a beneficial ownership test.3 Companies are required to “look through” the record ownership of certain nominee holders, such as brokers, dealers or banks holding securities for the accounts of their customers, to determine the residency of those customers. Given the practical difficulties of the look through approach, the SEC only requires foreign companies to examine voting securities held of record in the jurisdictions that should account for most of the company’s trading volume and that are most likely to produce the greatest number of U.S. beneficial owners: the United States, the company’s home jurisdiction and the primary trading market for its securities. If after reasonable inquiry and having made a good faith effort the company is unable to obtain information about the customer accounts of nominee holders, including under the circumstance where the costs for supplying the requested information would be unreasonable, the company may rely on the presumption that such accounts are held in the principal place of business of such nominee holder. Companies also need to consider any beneficial ownership reports publicly filed, such as beneficial ownership reports on Schedule 13D or 13G filed with the SEC, or provided to the company or other information available to it when determining U.S. ownership.
U.S. Business Contacts
If the U.S. ownership of a foreign company’s voting securities exceeds 50%, the company will not qualify as a foreign private issuer only if it triggers any of the following three tests:
- Citizenship and Residency of Executive Officers and Directors. If a majority of either the executive officers or directors of a foreign company are U.S. citizens or residents, the company will not qualify as a foreign private issuer. Importantly, both the citizenship and residency of the executive officers, as a group, and the directors, as a group, must be analyzed separately. In determining the relevant group of executive officers to analyze, companies are directed to the definition of “executive officer” found in Exchange Act Rule 3b-7 and in Rule 405 under the Securities Act of 1933, as amended (the “Securities Act”). Under these rules an “executive officer” means a company’s president, any vice president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions for the company, which may include executive officers of subsidiaries. In analyzing the citizenship and residency of directors of a foreign company, the company should consider individuals that perform the functions generally performed by the board of directors of a U.S. company and, similarly, if there is more than one board of directors, the company should determine which board or members of the boards perform functions most like those of a U.S. style board of directors.
- Location of Assets. If more than 50% of a foreign company’s assets are located in the United States, the company will not qualify as a foreign private issuer. The SEC has noted that a foreign company must consider the location of both its tangible and intangible assets. Although there is no official SEC guidance on the methodology to employ in the analysis, a company’s balance sheet and the accounting methodology used in its underlying financial statements may serve as the most suitable starting point. However, other methodologies may be better suited or more appropriate given a particular company’s business. In addition, the determination of the location of the assets may require a case-by-case approach given the nature of the assets and how the company accounts for them in its financials. As this U.S. business contacts test requires an analysis of a company’s assets, companies should consult with their accountants in the determination of the appropriate methodology to employ and the application of the test.
- Administration of Business. If a foreign company’s business is administered principally in the United States, the company will not qualify as a foreign private issuer. The SEC has indicated several factors that a company could consider in making this determination, including the location of the company’s principal business segments or operations, the locations of board and shareholder meetings, the location of the company’s headquarters and where the most influential key executives (potentially a subset of all executives) are located or spend most of their time. Other factors include the percentage of working days key executive officers (e.g., the chief executive officer and the president) spend inside the United States, the locations where a company’s principal business functions (e.g., finance, accounting, manufacturing and marketing) are administered and the percentage of overall sales derived from outside of the United States.4
Consequences of Not Qualifying as a Foreign Private Issuer
If more than 50% of a foreign company’s outstanding voting securities are owned by U.S. residents and the company meets one or more of the U.S. business contacts tests as of the end of its second fiscal quarter, the company will no longer qualify as a foreign private issuer. As a result, the company must comply with the more stringent SEC reporting obligations applicable to domestic issuers beginning on the first day of the company’s next fiscal year, or six months after the company determines it no longer qualifies as a foreign private issuer.5 This six-month period is intended to provide companies with sufficient time to prepare for and transition to the domestic SEC reporting requirements and forms. For example, a foreign company with a December 31 fiscal year end that no longer qualifies as a foreign private issuer as of June 30, 2014 will have to file a Form 10-K (as opposed to a Form 20-F) in 2015 for its fiscal year ending December 31, 2014 (notwithstanding that it qualified as a foreign private issuer for half of the year), will become subject to the quarterly and current reporting requirements on Forms 10-Q and 8-K, respectively, and will have to begin complying with the proxy rules and Section 16, in each case as of January 1, 2015. One of the most significant consequences faced by a company that no longer qualifies as a foreign private issuer is that it can no longer present its financial statements in accordance with IFRS (or home-country GAAP with a reconciliation to U.S. GAAP), but must instead present its financial statements in accordance with U.S. GAAP.
The loss of foreign private issuer status is a significant event for any foreign company. Several key takeaways to be mindful of with respect to assessing, maintaining or anticipating a change in foreign private issuer status include:
- companies should monitor the factors that may disqualify them from foreign private issuer status, particularly if their U.S. ownership is near or above 50%, by, for example:
- periodically verifying the residency of executive officers and directors, not only when new executive officers and directors are appointed or elected or otherwise change, but also when existing executive officers and directors relocate;
- being mindful of where board and shareholder meetings are held and the number of days executive officers are spending at the company’s U.S. locations;
- anticipating the impact that corporate or other transformative business transactions may have on any of the factors, such as the acquisition or sale of significant assets;
- even if a foreign company is or becomes majority-owned by U.S. residents, it can remain a foreign private issuer as long as it does not meet any of the three U.S. business contacts tests discussed above; and
- if the eligibility criteria are no longer met (other than as a result of reincorporating in the United States), foreign companies are afforded a six-month transition period before being required to comply with the SEC’s domestic reporting obligations.