U.S. Legal Considerations Affecting Global Offerings of Shares in Foreign Companies

Northwestern Journal of International Law & Business, Dec 1996

The 1980s witnessed the emergence of so-called "global" equity offerings as part of the increasing internationalization of the world's capital markets. An equity offering can be said to be "global" when it involves simultaneous offerings of shares in a number of countries, one or more of which may be made to the public in accordance with the regulations of national markets. The capital markets of the United States can be included in a global equity offering in one of two ways: (1) shares may be offered to the public in accordance with the registration and disclosure requirements of the U.S. Securities Act of 19331 (Securities Act) and the regulations of the Securities and Ex- change Commission (SEC) thereunder; or (2) shares may be offered on a more limited basis in accordance with Rule 144A2 under the Se- curities Act or pursuant to traditional private placement procedures.

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U.S. Legal Considerations Affecting Global Offerings of Shares in Foreign Companies

Offerings of Shares in Foreign Companies U.S. Legal Considerations Affecting Global Offerings of Shares in Foreign Companies Daniel A. Braverman 0 0 This Article is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for inclusion in Northwestern Journal of International Law & Business by an authorized administrator of Northwestern University School of Law Scholarly Commons - U.S. Legal Considerations Affecting Global Offerings of Shares in Foreign Companies I. INTRODUCTION The 1980s witnessed the emergence of so-called "global" equity offerings as part of the increasing internationalization of the world's capital markets. An equity offering can be said to be "global" when it involves simultaneous offerings of shares in a number of countries, one or more of which may be made to the public in accordance with the regulations of national markets. The capital markets of the United States can be included in a global equity offering in one of two ways: (1) shares may be offered to the public in accordance with the registration and disclosure requirements of the U.S. Securities Act of 19331 (Securities Act) and the regulations of the Securities and Exchange Commission (SEC) thereunder; or (2) shares may be offered on a more limited basis in accordance with Rule 144A2 under the Securities Act or pursuant to traditional private placement procedures. When a public offering or private placement is made in the United States as part of a global offering, the structure of the offering as a whole will be significantly affected both because of the requirements that will apply in the United States, with which the require* Mr. Braverman is a partner in the London office of Cleary, Gottlieb, Steen & Hamilton. This article is an updated and expanded version of his chapter of the same title in Joseph J. Norton & Raymond M. Auerback, InternationalFinancein the 1990s: Challengesand Opportunities (Blackwell Publishers 1993) and is often used by the author in connection with presentations and conferences. The author is grateful to his many colleagues at Cleary, Gottlieb, Steen & Hamilton who have assisted from time to time in the preparation of this article. 1 15 Securities Act of 1933, U.S.C. § 77a et seq. (1994) [hereinafter Securities Act]. 2 17 C.F.R. § 230.144A (1996). ments of other countries will have to be coordinated, and because of the extraterritorial effect of U.S. laws and regulations on the activities of the participants in the portion of the offering being made outside the United States. This article first outlines the most important laws and regulations that apply to public offerings and private placements in the United States and then analyzes how these laws and regulations can affect the structure and conduct of the offering outside the United States. While the focus of the article is on global offerings of shares in foreign companies, the rules applicable to U.S. companies are also noted where they differ in substance. It must be stressed at the outset that the U.S. regulatory regime has evolved significantly in recent years in order to facilitate global offerings, and further changes can be expected. In the early 1980s, the SEC attempted to encourage U.S. public offerings of shares in foreign companies by tailoring the disclosure requirements more closely to home country requirements. In 1990, the SEC adopted Rule 144A under the Securities Act, which simplifies the procedures for making private placements to large U.S. institutions, 3 and Regulation S4 under the Securities Act, which ensures that offerings can be made outside the United States without registration under the Securities Act.5 Throughout the 1980s and into the 1990s, the SEC also took steps to limit the extraterritorial application of its restrictions on market activities by participants in an offering while a U.S. distribution is under way, thereby reducing the impact of a U.S. tranche on the activities of foreign underwriters in foreign markets in a global offering. Other measures, such as allowing a foreign securities broker or dealer to solicit business in the United States in certain circumstances without having to register with the SEC as a broker or dealer and permitting a foreign bank or insurance company to offer its securities to the U.S. public without having to register with the SEC as an investment company were also part of the SEC's multifaceted response to internationalization. Finally, in a move that bears little on this article, the SEC adopted a bilateral, multijurisdictional disclosure system with Canada permitting certain large issuers to use the offering documents of their home country when making a public offering of securities in the other country. In the light of these developments, it is important to recognize the protean character of the U.S. regulatory system as it applies to global offerings. Of necessity, this article can represent only a snapshot of a dynamic system that is ever changing in order to better accommodate the ebb and flow of capital across borders and to better integrate the U.S. capital markets with those of the rest of the world. II. U.S. LAWS AND REGULATIONS The Securities Act is the principal statute governing the distribution of securities in the United States. Any offer or sale of securities in the United States must be registered with the SEC under the Securities Act,6 unless an exemption is available.7 In the context of a global equity offering, the only relevant exemption for offers and sales in the United States is the one for a private placement that is made either under Rule 144A or on the basis of traditional private placement procedures. Before proceeding to discuss registered public offerings and private placements, a word should be said about what is not treated here. This article does not discuss the requirements for obtaining a listing on a major U.S. stock exchange, such as the New York Stock Exchange or the American Stock Exchange, or a quotation on the National Association of Securities Dealers' Automated Quotation System (NASDAQ). These requirements are generally easy to meet in the context of a public offering since the information required by the relevant application will, for the most part, be contained in the filings made with the SEC under the Securities Act (and are irrelevant in private placements since the securities being offered will not be listed on a U.S. exchange or quoted on NASDAQ). As a technical matter, when securities are listed on a U.S. exchange or quoted on NASDAQ, they are also required to be registered under the Securities Exchange Act of 19348 (Exchange Act), but that is also a routine procedure in the context of a public offering. Secondly, this article does not discuss American Depositary Shares (ADSs) or the American Depositary Receipts (ADRs) that evidence them. Shares of foreign companies are usually offered to the public in the United States in the form of ADSs and ADRs. An ADR is a negotiable certificate in registered form that evidences one or more ADSs, which, in turn, represent the underlying foreign shares on 6 See Securities Act § 77e. 7 See Securities Act § 77c (exempted securities); Securities Act § 77d (1994) (exempted transactions). 8 Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (1994) [hereinafter Exchange Act]. a share-for-share or multiple-share basis. ADRs are usually issued by a U.S. commercial bank (Depositary) whose foreign correspondent (Custodian) deposits the underlying shares pursuant to a Deposit Agreement between the issuer and the Depositary. ADRs can be submitted by the ADR holder to the Depositary for cancellation and delivery of the underlying shares. Similarly, underlying shares can be deposited with the Custodian against issuance by the Depositary of ADRs. ADRs facilitate sales of ADSs between U.S. investors, since transfers may be registered on the books of the Depositary in the same manner as transfers of shares in U.S. companies and the ADRs are eligible for clearance through The Depository Trust Company (DTC); accordingly, U.S. investors are not required to follow foreign transfer procedures or to send their certificates abroad.9 It is generally the case in a public offering that ADSs, rather than the underlying foreign shares, are quoted on a U.S. securities exchange or on NASDAQ so as to provide a U.S. dollar market once the public offering is launched. ADRs also permit U.S. investors to receive their dividends in dollars; dividends on the underlying shares paid in foreign currency 9 Privately placed ADSs of foreign companies may settle through DTC only if they are eligible for trading through PORTAL, a market for trading privately placed securities organized by the National Association of Securities Dealers, Inc. This market is, however, limited to securities that are eligible for resale under Rule 144A. Accordingly, private placements of shares that are not eligible for resale under Rule 144A generally may not settle through DTC. Settlement mechanics vary considerably in global offerings, although simultaneous delivery against payment is a common element. The simplest case is when ADSs are offered and sold in the United States and ordinary shares are offered and sold abroad. In these circumstances, the ADSs would typically be evidenced by a single global ADR held by DTC and the ordinary shares would settle in accordance with customary practice in the issuer's home market. (This approach would also be followed in global offerings in which the U.S. investors are given the option of taking either ADSs or ordinary shares - if they choose to take ordinary shares, settlement would be in accordance with home market practice.) If the ADSs - or global depositary shares - are to be offered abroad, the situation gets more complicated. Euroclear and CEDEL, the principal European clearing systems, have decided not to hold ADRs that evidence ADSs offered and sold in the United States; they will, however, hold through DTC interests in ADRs that are held by DTC; and they also will hold ADRs that evidence ADSs offered outside the United States. Thus the possibilities are as follows: a single global ADR evidencing ADSs sold everywhere could be held by DTC, with the European clearing systems holding interests in this ADR through DTC; two global ADRs, one evidencing the ADSs offered and sold in the United States and the other evidencing the ADSs offered and sold abroad, could be held by DTC, with the European clearing systems holding interests in the latter through DTC; or DTC could hold one global ADR evidencing the ADSs offered and sold in the United States and the European clearing systems could hold through a common depositary one global ADR evidencing the ADSs offered and sold abroad. The decision as to which of these options to choose is likely to depend on whether the U.S. tranche is public or private and whether it is large or small relative to the size of the offering in the rest of the world. are collected by the Custodian, converted into dollars and transmitted by the Depositary to the ADR holders. For purposes of the Securities Act, an ADS is technically a separate security, the offer or sale of which must be registered with the SEC, as must the offer or sale of the underlying shares, unless an exemption is available.1" A simple registration form - Form F-6 under the Securities Act - may be used to register the ADSs. 11 Thirdly, this article does not discuss the securities laws of the fifty states - the so-called "blue sky" laws - which, in many cases, contain both registration requirements and anti-fraud protections. It is generally the task of U.S. underwriters' counsel to ensure that all regulatory hurdles have been cleared in each state where the shares are to be offered or sold. In a public offering, the registration requirements of most states can be avoided by ensuring that the shares are approved for listing on a U.S. securities exchange or for quotation on NASDAQ before offers are made. Most blue sky laws also provide exemptions for private placements to institutional investors. Finally, this article does not discuss the U.S. tax aspects of global offerings. Among the most significant of these for the marketing of a global equity offering in the United States are the unfavorable tax rules that apply to U.S. purchasers of shares in companies deemed to be passive foreign investment companies (PFICs) for purposes of the U.S. Internal Revenue Code of 198612 (the Code). A PFIC is a foreign company that is engaged predominantly in the making of passive investments. The United States has developed special rules to discourage U.S. investors from seeking to defer U.S. taxation of their investment income by moving it offshore through the acquisition of equity securities in a PFIC that does not distribute its earnings currently. The rules require U.S. investors in a PFIC to pay what amount to significant penalties upon the sale or other disposition of an equity interest in the PFIC and on certain distributions by the PFIC. Alternatively, a U.S. investor in a PFIC may elect to report its pro rata share of the PFIC's earnings annually, without regard to whether those earnings have been distributed as dividends, by electing to treat the PFIC as a "qualified electing fund" for tax purposes; such 10 The offer and sale of ADSs in a private placement in the United States is not required to be registered. The deposit agreement for one of these so-called "restricted ADR programs" would contain restrictions on deposit and withdrawal to ensure on a continuing basis that the ADSs and underlying shares are offered and sold only to investors who are permitted to buy them in private placements that are exempt from registration under the Securities Act. 11 Securities Act, supra note 1. 12 Internal Revenue Code of 1986, 26 U.S.C. §§ 1-9722 (1994). an election is only available, however, if the PFIC has agreed to comply with potentially burdensome reporting requirements and has the additional disadvantage of requiring payment of taxes on income not yet realized. A foreign company will be classified as a PFIC if, during any taxable year, seventy-five percent or more of its gross income is passive income within the meaning of the applicable rules, or fifty percent or more of its assets are held for the production of passive income. Under the rules, an offshore mutual fund will generally be classified as a PFIC. Moreover, because the rules are drafted broadly, they may sometimes apply to foreign banks, insurance companies, property holding companies, start-up companies and other companies that would appear to be genuine operating companies. If the PFIC rules apply, the tax consequences can have a significant adverse impact on the marketing of a global offering in the United States. Indeed, to my knowledge, there has not been a single U.S. public offering of shares in a PFIC, and the rules have imposed significant limitations on the marketing of shares in U.S. private placements as well. 13 A. Public Offerings in the United States A U.S. public offering with a U.S. stock exchange listing or NASDAQ quotation is the route usually followed when a foreign private issuer'4 wishes to gain the widest access to the U.S. capital markets, to build a stable shareholder base in the United States and to encourage the emergence of a secondary trading market there. The U.S. regulatory regime is, however, extremely rigorous when securities are being 13 One solution in private placements has been to limit sales to entities that are exempt from U.S. taxation. Many of these entities, however, are pension plans subject to the Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001 et seq. (1994) [hereinafter ERISA], which imposes a number of restrictions, one of the most significant being that if pension plans, whether or not subject to ERISA (and whether or not located in the United States), hold more than 25 percent of the shares of a non-operating company, any pension plan subject to ERISA must treat the assets of the company as assets of the plan, a result that will generally cause the ERISA plan manager to be in violation of ERISA rules (this is the so-called "plan asset" problem). 14 A foreign private issuer is any company incorporated under the laws of a foreign country, except for a company that meets the following conditions: (1) more than 50 percent of its outstanding voting securities are held of record by U.S. residents; and (2) any of the following: (a) the majority of its executive officers or directors are U.S. citizens or residents, (b) more than 50 percent of its assets are located in the United States, or (c) its business is administered principally in the United States. 17 C.F.R. 17 C.F.R. § 240.3b-4(c) (1996). If a foreign company is not a foreign private issuer, it is treated as a U.S. issuer and certain of the disclosure and other requirements discussed below are more extensive. offered to the public. The most significant requirements are those imposed by: (1) the registration and related requirements of the Securities Act, which cover disclosure and publicity; (2) Rules 10b-6, 15 10b716 and 10b-817 under the Exchange Act (collectively, the Trading Rules), which regulate the market activities of the issuer and the underwriters while a distribution of securities is under way; and ( 3 ) the rules of the National Association of Securities Dealers, Inc. (the NASD), which are designed to ensure that members of the public are treated no less favorably than institutional investors and other institutional participants in the capital markets. Other restrictions, such as those imposed by section 7(d) of the Investment Company Act of 194018 (the Investment Company Act), which prevents a foreign "investment company" from offering its shares to the public in the United States without registering with the SEC as an investment company,19 and by section 15(a)(1) of the Exchange Act,20 which prevents any securities broker or dealer that has not registered as such with the SEC from offering securities in the United States, are also relevant.2' 1. Registrationand Related Requirements The purpose of the registration requirements of the Securities Act, broadly speaking, is to ensure that investment decisions in a U.S. public offering are made on the basis of disclosures mandated by the SEC and are not influenced by unwarranted publicity. Under § 5 of the Securities Act, it is unlawful for any person: * to offer any security for sale unless a registration statement in a prescribed form (including a preliminary prospectus) has first been filed with the SEC; 22 " to use any written information that offers any security for sale (Le., a statutory "prospectus"' 3) unless it meets the disclosure requirements of the Securities Act (as a practical matter, this ensures that the only written information made available in connection with a U.S. public 15 17 C.F.R. § 240.10b-6 (1996). 16 17 C.F.1R § 240.10b-7 (1996). 17 17 C.F.R. § 240.10b-8 (1996). I8 Investment Company Act of 1940, 15 U.S.C. § 80a-7(d) (1994) [hereinafter Investment Company Act]. 19 Id. 20 17 C.F.R. §240.15(a)(1) (1996). 21 Id. 22 Securities Act § 77e. 23 The definition of "prospectus" is contained in section 2(10) of the Securities Act, 15 U.S.C. § 77b(1), and generally covers "any prospectus, notice, circular, advertisement, letter or communication, written or by radio or television, which offers any security for sale ... ". Id. offering is 2t4he preliminary prospectus included in the registration statement); " to confirm the sale of any security until the registration statement has been declared "effective" by the SEC;25 and " to deliver any security (or any written confirmation of sale) until a final prospectus meeting the disclosure requirements of the Security Act have been furnished to the purchaser (as a practical matter, this requires the prospectus that is included in the registration statement wwihtehnoirt ipsridoercltaoretdheefcfoencftiivrmeattoiobne odfelsiavleer)e.2d6 to the purchaser together The effect of these rules is generally to prohibit marketing efforts in connection with a public offering until a registration statement has been filed, to limit the use of written materials in connection with any marketing efforts to the preliminary prospectus that is included in the registration statement, and to prevent sales from being confirmed until the registration statement has been declared effective and the final prospectus prepared, typically after review by the SEC to ensure that the disclosure requirements have been met. Generally, the underwriting agreement is signed and the securities are priced when the registration statement is declared effective or shortly thereafter. Disclosure Requirements The disclosure requirements for the prospectus included in a registration statement are set out in detailed SEC regulations and forms. The information called for is extensive - going well beyond what is required by regulators in most other countries - and only those requirements that are generally thought to be most significant for foreign issuers can be touched on here. The relevant forms for a foreign company wishing to offer its shares to the U.S. public are Forms F-1, F-2 and F-3 under the Securi24 Securities Act § 77e. Rule 430A under the Securities Act, 17 C.F.R. § 230.430A (1996), provides that in most cases the preliminary prospectus included in the registration statement will be deemed to meet the disclosure requirements of section 5(b)(1) of the Securities Act, 15 U.S.C. § 77e(b)(1). 25 Securities Act § 77e. 26 Ld. Note, however, that Rule 430A under the Securities Act, 17 C.F.R. § 230.430A, provides that certain information relating to the pricing of the securities and the composition of the underwriting syndicate will be deemed to be contained in the prospectus included in the registration statement when it is declared effective, even if such information is omitted from that prospectus; the final prospectus delivered to investors is required to contain this information. Ld. In addition, Rule 424(b) under the Securities Act, 17 C.F.R. §230.424(b)(1996), allows certain changes, even substantive ones, to be made in the final prospectus after the registration statement is declared effective. Id. ties Act.2 7 Form F-1 is for an issuer that is not subject to the periodic reporting requirements of the Exchange Act28 or that is subject to those requirements but is not otherwise eligible to use Forms F-2 or F3. Forms F-2 and F-3 are available to an issuer that is subject to the periodic reporting requirements of the Exchange Act, provided certain other conditions are met. A foreign issuer will be eligible to use Form F-3 if: * it has been subject to the periodic reporting requirements of the Exchange Act for at least twelve months, has filed at least one annual report on Form 20-F and has fi2l9ed all required reports in the last twelve months on a timely basis; * in the case of primary offerings of shares for cash, its voting stock held by non-affiliates has an aggregate worldwide market value (the socalled "float") of at least $75 million;30 and " it has not defaulted on certain payments.3 ' An issuer that satisfies the float requirement but that has not been subject to the periodic reporting requirements for at least twelve months will be eligible to use Form F-2, so long as it has filed at least 27 17 C.F.R. §§ 239.31-.33 (1996). These forms, adopted in 1982, represent an effort by the SEC to tailor the disclosure requirements for a U.S. public offering more closely to the requirements of the issuer's home country. The accommodations, however, are rather limited in scope. For a discussion of these forms, see generally Edward F. Greene & Eric D. Ram, Securities Law Developments Affecting ForeignPrivateIssuers,IVrr'L FIN. L. REv. 4 (1983). For U.S. issuers, the comparable forms are Form S-1, 17 C.F.R. § 239.11 (1996), Form S-2, 17 C.F.R. § 239.12, and Form S-3, 17 C.F.R. § 239.13. 28 A foreign company can become subject to the periodic reporting requirements of the Exchange Act, set out in section 13 of the Exchange Act, 15 U.S.C. § 78m, by making a public offering in the United States, see Exchange Act §78o(d), or by registering a class of its securities under the Exchange Act. A foreign company is required to register a class of its securities under the Exchange Act if it obtains a listing or quotation for that class on a U.S. securities exchange or on NASDAQ, Exchange Act § 781(b), or, in the case of a class of equity securities, if there are 300 or more U.S. resident beneficial owners of shares in that class, 17 C.F.R. § 240.12g3-2(a) (1996). Rule 12g3-2(b) under the Exchange Act provides an exemption from Rule 12g3-2(a)'s requirement to register so long as the issuer agrees to furnish to the SEC the significant information it makes public in its home country, files with a stock exchange on which its securities are listed or distributes to its security holders. For a critique of Rule 12g3-2(b) in the current environment, see Edward F. Greene et al., Hegemony orDeference: U.S. DisclosureRequirementsin the International Capital Markets, 50 Bus. LAw. 413 (1995) [hereinafter Hegemony or Deference]. A foreign company that is subject to the periodic reporting requirements of the Exchange Act must file an Annual Report on Form 20-F, 17 C.F.R. § 239.33 (1996), within six months of the end of its financial year, including audited financial statements reconciled to U.S. generally accepted accounting principles (U.S. GAAP) and Reports on Form 6-K, which must contain significant information the company makes public in its home country, files with a securities exchange or distributes to security holders. 29 17 C.F.R. § 239.33(a)(1)-(2). 30 17 C.F.R. § 239.33(b)(1). 31 17 C.F.R. § 239.33(a)( 3 ). one annual report on Form 20-F and has filed all other required reports on a timely basis.3 2 If the issuer does not meet the float requirement, it will be eligible to use Form F-2 only if it has been subject to the periodic reporting requirements of the Exchange Act for at least thirty-six months and has filed all required reports on a timely basis. The forms differ mainly in the extent to which they permit information about the issuer to be incorporated in the prospectus by reference to previous reports filed under the Exchange Act, Form F-3 being the most permissive in this regard. All the forms refer to Regulation S-X33 under the Securities Act for the requirements regarding financial statements and to Form 20-F for the other disclosure requirements. The prospectus to be used in a public offering must contain financial statements that have been audited on the basis of auditing standards that are generally accepted in the United States.34 While these standards are in certain respects more rigorous than those applied elsewhere, 5 audits conducted by major international accounting firms generally will meet the U.S. requirements, as will audits conducted in accordance with the auditing standards of the United Kingdom.36 The financial statements may be presented in accordance with accounting principles that are generally accepted in the issuer's home country, so long as the main differences between those principles and generally accepted accounting principles in the United States (U.S. GAAP) are explained and numerical reconciliations to U.S. GAAP of the principal income statement and balance sheet items are provided.37 Although the financial statements may be prepared on the basis of other accounting principles, they must be similar in scope to those prepared in accordance with U.S. GAAP and therefore must include audited balance sheets as of the end of each of the issuer's two most 32 17 C.F.R. § 239.32(b)(1)-(2) (1996). 33 17 C.F.R. § 239.32(b)(1)(i). 34 17 C.F.R. § 210 et seq. (1996). 35 Rule 2-02(b) of Regulation S-X, 17 C.F.R. § 210.2-02(b), under the Securities Act requires the audit report to state that the audit was conducted in accordance with U.S. generally accepted auditing standards. While the rule contemplates that exceptions may be taken, it goes on to state that "nothing in this rule shall be construed to imply authority for the omission of any procedure which independent accountants would ordinarily employ in the course of an audit," 1d., and the SEC has taken a hard line on this issue. 36 Some procedures required by U.S. auditing standards, such as observation of physical inventory and other fieldwork, may not be customary in certain countries. 37 The audit report contained in a registration statement for a U.K. company would typically state that the audit was "conducted in accordance with auditing standards generally accepted in the United Kingdom, which do not differ in any material respect from those in the United States." recent financial years and audited statements of income, cash flows and changes in stockholders' equity for each of its three most recent financial years.3" The financial statements must have an informational content substantially similar to that required by U.S. GAAP;39 accord38 17 C.F.R. § 249.220f [Item 18(c)]. Numerical reconciliations generally are required for each year and for any interim periods for which a balance sheet, income statement and statement of cash flows is required (see the discussion below). Generally, this means that net income and cash flows must be reconciled for three years and shareholders' equity for two years. However, reconciliation of net income and cash flows for the earliest of the three years may be omitted if that information has not previously been included in a filing with the SEC. [Items 18(c)(2)(i)-(iii) of Form 20-F]. Moreover, if the statement of cash flows is prepared in accordance with International Accounting Standards No. 7, no reconciliation to U.S. GAAP is required. [Item 18(c)(2)(ii) of Form 20-F] Exceptions to the reconciliation requirement also apply in certain cases to financial statements that account for price level changes in certain ways or that are prepared for businesses acquired or to be acquired, for certain investee companies or for certain joint ventures. [Items 18(c)(2)(iv)-(vii) of Form 20-F]. The numerical reconciliations can reveal significant variations: for one U.K. company, BET, net income attributable to ordinary shareholders for the financial year ended March 31, 1991, was £150.0 million under generally accepted accounting principles in the United Kingdom (U.K. GAAP) but only £77.4 million under U.S. GAAP, while shareholders' equity at the financial year-end was only £472.8 million under U.K. GAAP but £1,585.4 million under U.S. GAAP; and for the first six months of the financial year ending March 31, 1992, net income attributable to ordinary shareholders under U.K. GAAP was £65.2 million, while there was a loss of £306.7 million under U.S. GAAP. The differences in these results were attributable principally to the treatment of goodwill arising as a result of acquisitions, which is written off against shareholders' reserves in the year of acquisition under U.K. GAAP but is recorded on the balance sheet as an intangible asset and amortized over its estimated useful life (at most forty years) under U.S. GAAP. In the case of Daimler-Benz Aktiengesellschaft, net income for 1993 was DM 615 million under German GAAP while there was a net loss of DM 1,839 million under U.S. GAAP; stockholders' equity at December 31, 1993, was DM 18,145 million under German GAAP, but DM 26,281 million under U.S. GAAP. These differences resulted mainly from variances in the accounting treatment of provisions, reserves and valuation differences and, to a lesser extent, variances in accounting for business acquisitions, financial instruments, foreign currency translation and pensions and other postretirement benefits. Little evidence exists to show that reconciliations to U.S. GAAP, even when they reveal differences of this magnitude, have any impact on the price at which securities are bought and sold in the market. In the absence of such an effect, it is unclear what purpose is being served by this requirement, compliance with which can be time consuming and costly. For a critique, see generally Hegemony or Deference, supra note 28. 39 17 C.F.R. § 210.3-19(a). Rule 3-19(b) of Regulation S-X, 17 C.F.R. §210.3-19(b), under the Securities Act allows an issuer to provide audited financial statements as of the end of only the two financial years preceding the most recent financial year if (1) the audited balance sheet for the most recent financial year is not yet available; and (2) interim financial statements, which may be unaudited, as of a date within ten months of the effective date are provided. More stringent rules apply to U.S. companies. See 17 C.F.R. § 210.3-01(b)-(c). Separate financial statements of certain businesses that have recently been acquired or that are to be acquired, and pro forma financial statements taking account of such acquisitions (and certain dispositions), are also required to be included in certain circumstances. See 17 C.F.R. §§ 210.3-05, .11-01. In addition, separate financial statements may also be required for certain unconsolidated subsidiaries and certain entities in which the company has a 50 percent or lesser interest. 17 C.F.R. §210.3-09. ingly, "segment" financial data must be provided - i.e., information with respect to revenues, operating profits, assets and capital expenditures broken down by industry segment and geographic area.40 If a registration statement is declared effective more than ten months after the end of the issuer's most recent financial year, financial statements, which may be unaudited as of an interim date not more than ten months prior to the effective date of the registration statement, must be provided.41 Moreover, certain selected financial data must be included for each of the last five financial years, showing significant trends relating to revenues, income, liquidity, assets, liabilities, capital resources and dividends per common share.42 In addition to the financial data, the prospectus must include a complete description of the issuer's business, an analysis by management of the issuer's financial condition, results of operations, or sources of liquidity and, where appropriate, a discussion of the most significant risks associated with an investment in the securities. The description of the business must highlight, interalia, any special characteristics of the issuer's operations or industry that could have a material impact on future performance and must identify any material country risks.43 Examples of factors which might be discussed include dependence on one or a few major customers or suppliers (including suppliers of raw materials or providers of financing); existing or probable governmental regulation; expiration of material labor contracts, patents, trademarks, licenses, franchises, concessions or royalty agreements; unusual competitive conditions in the industry; the cyclic nature of the industry; and anticipated raw material or energy shortages to the extent management may not be able to secure a continuing source of supply.44 The description must also explain any material variations between the percentage of revenues contributed by each industry segment and geographic area on the one hand and If a foreign company's financial statements are prepared on the basis of U.S. GAAP, information for the earliest of these three years need not be provided for its initial U.S. public offering. 40 17 C.F.R. § 249.220f-18(b) (1996). 41 17 C.FR. § 249.220f-18(c)( 3 ). See also FINANCIAL ACCOUNTING FOR SEGMENTS OF A BUSINESS ENTERPRISE, Statement of Financial Accounting Standards No. 14 (Fn. Accounting Standards Bd. 1976). The requirement to prepare full segment data does not apply to pro rata rights offerings to shareholders. 42 17 C.F.R. § 210.3-19(c). Again, the requirements are more stringent for U.S. companies. See 17 C.F.R. § 210.3-01(e). 43 17 C.F.L § 249.220f-8. 44 17 C.F.R § 249.220f-1. the corresponding percentages of operating profit contributed by the same segments on the other.4 5 The management's discussion and analysis of financial condition and results of operations (MD&A) is intended to help investors understand the financial statements contained in the prospectus and to assess the sources, and probability of recurrence, of earnings or losses.4 6 The discussion is generally divided into two parts. In the first part, the issuer must describe any unusual events or significant economic changes that materially affected the level of income and any trends or uncertainties that have had, or that the issuer reasonably expects will have, a material impact on net sales or revenues or on income from continuing operations. 47 If the financial statements show material changes in net sales or revenues, the issuer must indicate the extent to which such changes are attributable to changes in prices or to changes in the quantities of goods or services being sold. The issuer also must discuss the impact of inflation on its sales, revenues and income for the three most recent financial years. Where its consolidated financial statements reveal material changes from one year to the next in any line item, the issuer must explain the changes to the extent necessary to understand its business as a whole. In the second part, the issuer is required to describe material commitments for capital expenditures (and any material trends in such expenditure) and to identify its financial resources (and any deficiencies in them).48 Any trends that are reasonably likely to result in material changes in the issuer's ability to finance its operations and capital expenditures also must be discussed.49 Where appropriate, the prospectus also is required to contain, under an appropriate caption following the cover page or the summary (if included), a discussion of the principal factors that make the offering speculative or one of high risk. These factors may include, among other things, such matters as the absence of an operating history of the issuer, the absence of profitable operations in recent periods, the uncertain financial position of the issuer, the nature of the business in which the issuer is engaged or proposes to engage or the absence of a previous market for the shares. Material country risks 45 17 C.F.R. § 249.220f-l(b). 46 17 C.F.R. §249.220f-l(a)(4). 47 17 C.F.R. § 249.220f-9. 48 ld. 49 17 C.F.R. § 249.220f-9(a)-(b). and other areas of vulnerability required to be disclosed in the business section are also generally highlighted in this discussion as well.5" For an issuer that has not previously offered securities to the U.S. public, at least two months should be allowed for the preparation of a registration statement for filing with the SEC. The SEC staff generally will take one month to review the filing and to comment on the disclosure. During this period, offers may be made on the basis of the preliminary prospectus. Unless the SEC's comments are unusually extensive, one week should be allowed to prepare a response. After that, the registration statement can be declared effective, the underwriting agreement signed, the securities priced on the basis of indications of interest (or circles) obtained from investors during the marketing period, and sales confirmed. There is usually a period of three business days between pricing and closing. So approximately three and one-half months should be allowed from the time preparation of a registration statement begins until the closing date. Significantly less time is required for issuers that have previously offered securities to the public in the United States and have been filing periodic reports with the SEC under the Exchange Act. The registration fee is 1/29th of one percent of the aggregate public offering price of the shares. 51 The SEC staff has been very helpful and flexible in assisting foreign issuers through the registration process. When necessary, the staff will review registration statements on an expedited basis and, when appropriate, will commence the review process in advance of a formal filing by accepting an informal, confidential submission, even if the registration statement is not yet complete. This practice emerged in the context of offerings where the timing was dictated by foreign requirements but is now available for most offerings by foreign companies. 50 In addition to requiring the disclosure of material trends, the SEC encourages the inclusion of projections in the prospectus, provided that the assumptions on which they are based are disclosed and the projections themselves have a reasonable basis. 17 C.F.R. § 229.10(b) (1996). Moreover, Rule 175 under the Securities Act, 17 C.F.R. § 230.175, and Rule 3b-6 under the Exchange Act, 17 C.F.R. § 240.3b-6, provide safe harbors from the liability provisions of those acts for certain projections made in good faith. Nonetheless, issuers are generally advised not to include projections in their SEC filings, since in hindsight their reasonable basis may be challenged too readily. On October 19, 1994, the SEC issued a concept release soliciting comments on whether the safe harbor provisions are effective and, if not, whether they should be revised and how. Securities Act Release No. 7101, 59 Fed. Reg. 52,723 (1994). 51 17 C.F.R. § 229.503(c). Civil Liability and Due Diligence The disclosure requirements are given their sting by the civil liabilities imposed by the securities laws, which give investors the right to rescind their purchases or to recover damages in certain circumstances. Section 11 of the Securities Act imposes strict liability on issuers for material misstatements or omissions in registration statements and liability, subject to a "due diligence" defense, on the directors, certain officers of the issuer and on the underwriters (or placement agents). Certain others, including auditors and other experts who consent to being named in the registration statement, also have section 11 liability. 2 In addition, section 12(2) of the Securities Act 53 imposes liability, subject to a "reasonable care" defense, on any52 Securities Act § 77f. 53 Section 11(a) of the Securities Act, 15 U.S.C. § 77k(a), states that any person who acquired a registered security may bring an action claiming that "any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading." Id. By its terms, section 11 of the Securities Act applies only in the context of a registered offering, and the plaintiff need not prove reliance (or even that he or she had received or read the prospectus), unless he or she bought the security after the issuer had made generally available to its security holders an earning statement covering a period of at least one year beginning after the effective date, but even then "reliance may be established without proof of the reading of the registration statement by such person." The "due diligence" defense is contained in section 11(b)( 3 ) of the Securities Act, 15 U.S.C. §77k(b)( 3 ), which provides that a defendant will not be liable for a material misstatement or omission under section 11 if he or she demonstrates that he or she had, after reasonable investigation, reasonable ground to believe and did believe that the statements contained in the registration statement were true and did not omit any facts required to make the statements not misleading. With respect to those statements in the registration statement that are made on the authority of a named expert who has consented to the mention of his name, the defendant need only establish that he or she had no reasonable ground to believe, and did not believe, that the statements were untrue or omitted facts required to make the statements not misleading. This more relaxed standard, which does not require a reasonable investigation, applies to the audited financial statements of the issuer, which are included in the registration statement on the authority of the issuer's independent accountants. A similar standard applies to statements made on the authority of a government official with responsibility for the matter in question, and to copies of or extracts from public official documents. Section 11(f) of the Securities Act, 15 U.S.C. §77k(f), provides that each person found liable under section 11 is jointly and severally liable with the others who could be found liable, but also provides that each may recover contribution from any person who, if sued separately, would also have been liable (except that contribution may not be recovered by a person guilty of fraudulent misrepresentation from a person not guilty of fraudulent misrepresentation). Actions must be brought under section 11 within one (1) year after the discovery of the untrue statement or omission or after such discovery should have been made by the exercise of reasonable diligence. In no event may any action be brought more than three years after the security was first offered to the public. See Securities Act §77m. In addition, controlling shareholders (or other controlling persons) of anyone liable under section 11 of the Securities Act have liability under section 15 of the Securities Act, 15 U.S.C. one who sells a security through any prospectus or oral communication containing a material misstatement or omission (the purchaser not knowing of such misstatement or omission).5 4 Finally, Rule 10b555 under the Exchange Act imposes liability on anyone who knowingly or recklessly makes an untrue statement of a material fact or omits to state a material fact in connection with the purchase or sale of a security.56 The litigious nature of American society, the relative ease with which class actions can be brought on behalf of similarlysituated shareholders and the prevalence of contingent-fee arrangements combine to ensure that the threat of civil liability is an effective means of keeping U.S. disclosure standards high.57 In order to establish a defense to claims under these liability provisions, the underwriters in a U.S. public offering engage in a "due § 770, subject to a defense similar to, but more easily established than, the "due diligence" defense under section 11. 54 Securities Act § 771(2). 55 Section 12(2) of the Securities Act, 15 U.S.C. § 771(2), refers to a prospectus or oral communication that "includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements [therein], in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission)." Id. The U.S. Supreme Court has recently held that section 12(2) of the Securities Act only applies to public offerings. See infra Part II.B.3.a. The courts have interpreted the word "seller" very broadly for purposes of section 12(2) of the Securities Act. In addition to embracing those who actually own and sell the security in question, the term has been construed to cover others with a financial interest in the sale who actively participate in its solicitation. Thus, investment banks acting as placement agents may be liable under section 12(2) of the Securities Act, as may directors, officers and principal shareholders who authorize the promotional efforts of the underwriters or placement agents, help prepare the offering documents or participate in meetings with salesmen or investors. See, eg., In re Craftmatic See. Litig., 890 F.2d 628, 636 (3d Cir. 1989); Wilson v. Saintine Exploration and Drilling Corp., 872 F.2d 1124 (2d Cir. 1989); Crawford v. Glennis, Inc., 876 F.2d 507 (5th Cir. 1989). Section 15 of the Securities Act, 15 U.S.C. § 77o, can also reach persons controlling those liable under section 12(2). The statute of limitations in actions under section 12(2) of the Securities Act is substantially the same as under section 11 of the Securities Act. 56 17 C.F.R. § 240.10b-5. 57 Rule 10b-5, 17 C.F.R. § 240.10b-5, states that: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange: (1) To employ any device, scheme or artifice to defraud, (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or ( 3 ) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. Section 17(a) of the Securities Act, 15 C.F.R. § 77q(a), and the state Blue Sky laws also provide for liability based on material misstatements or omissions in offering documents. These liability provisions are discussed briefly in Part II.B.3.a. diligence" exercise, with the assistance of their legal advisors. Among other things, this generally involves (1) meetings with the principal executive and financial officers of the issuer to assess operating and financial results, identify any vulnerabilities and discuss prospects; (2) a review of all the issuer's significant documents, including minutes of the meetings of its shareholders and of its board of directors (and the board's more significant committees) for the past five years, and the issuer's material contracts; ( 3 ) independently checking the issuer's relationships with its principal suppliers and principal customers; (4) reviewing with the issuer's independent auditors the adequacy of the issuer's systems of accounting and control; and (5) visits to the issuer's principal facilities. It is generally a condition to the closing of a U.S. public offering that the legal advisers to the issuer and to the underwriters give letters to the underwriters confirming that nothing has come to their attention to cause them to believe that the registration statement or final prospectus contains a material misstatement or omission. To be in a position to give these letters, the legal advisors participate closely in the preparation of the prospectus and in the due diligence meetings with top management and, of course, do the bulk of the review of the issuer's significant documents. It is also customary for the company's independent auditors to deliver to the underwriters "cold comfort letters" in standard form when the underwriting agreement is signed and at closing. The due diligence process is generally considered by foreign issuers to be burdensome, intrusive, time-consuming and expensive, but it is also acknowledged to be thorough and, perhaps, more likely to identify areas of business risk than the comparable exercises in other countries. c. Restrictions on Publicity The registration process and disclosure requirements are intended to ensure that potential investors are provided complete and accurate information about the issuer and to ensure that investment decisions are made on the basis of that information and are not influenced by advertising campaigns or other forms of publicity. The requirement that no "offer to sell" can be made until a registration statement has been filed prevents so-called "gun-jumping," which are efforts to "condition the market" in anticipation of an offering, and the prohibition on the use of written materials other than the preliminary prospectus after a registration statement has been filed precludes most forms of advertising, including newspaper, radio and television campaigns, which are common in some countries. The only marketing efforts permitted in connection with a U.S. public offering, other than the distribution of the preliminary prospectus, are so-called "road shows," in which executive officers of the issuer and representatives of the managing underwriter meet potential investors and give oral presentations, perhaps with slides, about the issuer and the offering, and respond to questions. The restrictions on publicity apply to the issuer at least from the time it "reaches an understanding" with the managing underwriter with respect to the offering, and may reach back to the time the issuer decides to proceed with a public offering. The investment bank selected to be the managing underwriter becomes subject to the restrictions when it begins to participate in the preparation of a registration statement or otherwise "reaches an understanding" with the issuer that it will become the managing underwriter. Other investment banks become subject to the restrictions when they are invited by the issuer or managing underwriter to participate, or when they seek to participate, in the offering. The restrictions on the issuer end when the distribution is over and securities dealers, whether or not they are participating in the distribution, are no longer required by the Securities Act to deliver prospectuses to purchasers. The restrictions on an individual securities dealer end when it has sold its allotment and is no longer required to deliver a prospectus.58 The period during which a prospectus is required by the Securities Act to be delivered by securities dealers varies depending on a number of factors. If the issuer was subject to the periodic reporting requirements of the Exchange Act 58 The SEC has resisted efforts by directors and officers to shift the risk of liability under the securities laws away from themselves and onto issuers through indemnification provisions. In the context of registered public offerings, the SEC has argued, and courts have agreed, that indemnification by an issuer of its directors and officers for violations of the securities laws is against public policy and thus unenforceable. See 17 C.F.R. § 229.512(h); Laventhol, Krekstein, Horwath & Horwath v. Horwitch, 637 F.2d 672, 676 (9th Cir. 1980), cert denied, 452 U.S. 963 (1981); In re Professional Fm. Management, Ltd., 683 F. Supp. 1283, 1285 (D. Minn. 1988); Kilmartin v. H.C. Wainwright & Co., 637 F. Supp. 938,940 (D. Mass. 1986); Odette v. Shearson, Hammill & Co., 394 F. Supp. 946 (S.D.N.Y. 1975). While the SEC has not extended this position to indemnities given by an issuer to its underwriters for material misstatements or omissions in information not provided by the underwriters, several courts have held that standard indemnification provisions in underwriting agreements that do just this are also against public policy and unenforceable. See e.g., Eichenholtz v. Brennan, 52 F.3d 478,484 (3d Cir. 1995); Globus v. Law Research Serv., Inc., 418 F.2d 1276,1288 (2d Cir. 1969), cert.denied, 397 U.S. 913 (1970). On the other hand, a company may buy insurance for its directors and officers and underwriters may also insure themselves against securities law liabilities; these arrangements have not been effectively challenged. A company is required, however, to disclose in the registration statement for a public offering the premiums it pays for its directors and officers' insurance with respect to liabilities that could arise in connection with the registration. prior to the filing of the registration statement, the period lasts until the dealer has distributed its allotment. If not, the period lasts until the later of the time when the dealer has disposed of its allotment and a time that varies as follows: * if arrangements are made to have the shares listed on a U.S. securities exchange or quoted on NASDAQ when the offering commences, twenty-five days thereafter; and " if no such arrangements are made, generally ninety days thereafter.59 The SEC has recognized that conservative interpretations of the restrictions on publicity in connection with a U.S. public offering could have adverse effects on the quality of information that flows into the market, since the issuer and the underwriters may fear that press releases and research reports could be viewed as unlawful "offers to sell" the securities being distributed or as "prospectuses" that do not meet the disclosure requirements. To reconcile the conflicting objectives of restricting the "hype" surrounding an offering while at the same time encouraging the flow of important information into the market, the SEC has issued a number of releases and rules providing guidance. In the releases, the SEC has encouraged issuers to continue to make factual information available to the public. The SEC has stated that issuers should: " continue to advertise products and services; " continue to send out customary quarterly, annual and other periodic reports to security holders; " continue to publish proxy statements and send out dividend notices; " continue to make announcements to the press with respect to factual business and financial developments; i.e., receipt of a contract, the settlement of a strike, the opening of a plant or similar events of interest to the community in which the business operates; " answer unsolicited telephone inquiries from security holders, financial analysts, the press and others concerning factual information; " observe an "open door" policy in responding to unsolicited inquiries concerning factual matters from securities analysts, financial analysts, security holders and participants in the communications field who have a legitimate interest in the corporation's affairs; and " continue to hold previously scheduled shareholder meetings and to answer shareholders' inquiries at shareholder meetings relating to factual matters. The SEC has warned, however, that the issuance of forecasts, projections, predictions or opinions concerning value should be avoided.6 ° 59 Securities Act Release No. 5009, 34 Fed. Reg. 16,870, at 16,870-71 (Oct. 7, 1969). 60 The general requirement that securities dealers, whether or not they are participating in the offering, deliver prospectuses to purchasers for a certain period is contained in sections 4( 3 ) The SEC has preliminarily determined that the stabilization rules of the U.K. Securities Investment Board (SIB) are comparable to Rule lOb-7 for these purposes. 220 To deal with the technical problems that arise in a global offering in connection with stabilization levels, the SEC issued a second set of proposed amendments at the same time. If adopted, these would allow: " stabilization to be initiated at a price determined by reference to the principal foreign market for the securities rather than a U.S. market; * a stabilizing bid to be placed in any market at the current exchange rate equivalent to a stabilizing bid entered in the principal foreign trading market for the securities; and " a stabilizing bid in a market other than the principal trading market to be adjusted in response to exchange rate fluctuations in the currencies in which the securities trade in such subsidiary markets against the currency in which the securities trade in the principal market. These proposed amendments would only apply where the principal trading market was on a "specified foreign securities market" - i.e., the London, Montreal, Paris, Tokyo or Toronto stock exchanges (or such other securities exchanges as the SEC may designate). 221 Pending the adoption of the proposed amendments, the SEC staff has indicated that it will not take enforcement action against any participant in a distribution that complies with the proposed rules.22 2 Both sets of proposed amendments are codifications of no-action positions taken by the SEC in the context of particular offerings and in response to specific requests for relief. Application will still have to be made to the SEC on a case-by-case basis in circumstances where the proposed amendments do not apply. 220 Stabilizing to Facilitate a Distribution, 56 Fed. Reg. at 817. 221 Id. at 816. The proposed definition of "specified foreign securities market" is discussed in Definitions Principally Relating to International Transactions, Exchange Act Release No. 28,733, 56 Fed. Reg. 820, at 821 (Jan. 9, 1991). Factors that the SEC will consider in deciding whether to designate a particular market are whether it has an established operating history, is subject to oversight by an authority that has a written understanding with the SEC that provides for cooperation and enforcement coordination in regulatory and enforcement matters, requires securities transactions to be reported on a regular basis to a governmental or self-regulatory body, has a system for public dissemination of price quotations, has sufficient trading volume to indicate liquidity and has adequately capitalized financial intermediaries. Id. at 821. 222 Stabilizing to Facilitate a Distribution, 56 Fed. Reg. at 819. For further discussion of the proposed amendments, see Richard J. Bauerfeld, SEC Eases Up on Applying U.S. Rules to Global Deals, INVESTmENT DEALERs' DiG. (Mar. 11, 1991). d. Rule lOb-8 The SEC has recognized that Rule 10b-8 creates problems similar to those raised by Rule 10b-7. In the context of rights offerings by U.K. issuers, the SEC has granted a series of exemptions from the extra-territorial application of Rule 10b-8 for certain activities that go beyond passive market-making, so long as the exercise price represented a discount of at least 10% from the share price.22 3 In addition, the SEC has permitted British issuers to adjust the Lay-Off Price and the price at which distribution participants could purchase rights to take account of fluctuations in exchange rates.2 4 Finally, the SEC has permitted British issuers to adjust the Lay-Off Price in the United States and the price at which the distribution participants can purchase rights in the United States to take into account trading in the principal market abroad.2 5 4. The NASD Rules Section 24(c) of the Rules of Fair Practice of the NASD obliges any member of the NASD who grants a selling concession, discount or other allowance to a non-member broker, dealer or other person in a foreign country in connection with a sale of registered shares in a U.S. public offering to obtain from such person an agreement that it will comply with the requirement that the shares be offered at the public offering price, even outside the United States, subject to such selling concessions, discounts or other allowances as would be permitted by NASD members. Similarly, paragraph 8(a) of the interpretation of the Board of Governors of the NASD regarding free riding and withholding obliges a member of the NASD who sells shares to a foreign broker, dealer or bank who is participating in the distribution as an underwriter to obtain an agreement from such underwriter that it will abide by the rules requiring the benefits of "hot issues" to flow to the investing public. These obligations to obtain agreements from the foreign participants in a distribution will apply in a global equity offering whenever sales of shares are made from the U.S. syndicate to the international 223 Saatchi & Saatchi Company, SEC No-Action Letter, 1993 SEC No-Act. LEXIS 879 (May 19, 1993), supra note 226, and British Airways PLC, SEC No-Action Letter, 1993 SEC No-Act. LEXIS 718, supranote 226. 224 Tricentrol Limited, SEC No-Action Letter, 1980 SEC No-Act. LEXIS 3547 (July 2, 1980) and its progeny. 225 Daimler-Benz Aktiengesellschaft, SEC No-Action Letter, 1994 SEC No-Act. LEXIS 571 (June 20, 1994). syndicate pursuant to the orderly marketing agreement. Because it is impossible to know in advance whether any such sales will be made (or in many cases when they are made, whether any particular offer and sale to the public outside the United States is of shares that were part of the international syndicate's initial allocation from the issuer or of shares that were transferred to it pursuant to the orderly marketing arrangements), the relevant NASD rules are generally applied uniformly. While abiding by these rules does not impose significant burdens on the international underwriters, it may require them to comply with obligations to which they are not accustomed and which are not imposed on them by the rules of the national markets in which they operate. 5. Other considerations The restrictions on the ability of a foreign investment company to offer shares to the public in the United States imposed by the Investment Company Act are discussed in part II.A.4, as are the limitations that apply to the U.S. activities of foreign broker-dealers. Global Equity Offering Involving a U.S. Private Placement When a global equity offering involves a U.S. private placement instead of a public offering, the impact of the U.S. laws and regulations is far less significant. Moreover, the syndicate structure is often simplified, the private placement in the United States being made by U.S. affiliates of one or more of the underwriters in the international syndicate, or by such underwriters themselves in accordance with the requirements of Rule 15a-6.22 6 Registrationand Related Requirements Since the registration requirements of the Securities Act do not apply, the structure and conduct of the U.S. placement is likely to conform in a number of important aspects to the needs of the foreign participants in the offering, which will be influenced principally by the commercial and legal requirements of foreign markets. Perhaps most important, the timing of offers and sales is no longer driven by the registration process and will generally be determined by foreign rather than U.S. considerations, with a corresponding increase in flexibility. 226 It is now common for foreign companies that offer and sell shares in the United States under Rule 144A, 17 C.F.R. § 230.144A, to exchange those restricted shares for unrestricted SEC registered shares when they list or conduct a public offering in the United States. The issues relating to these exchange offers are beyond the scope of this article. Moreover, because the extensive disclosure requirements of the SEC's regulations and forms do not apply, the private placement memorandum to be used in the United States will often be the foreign offering circular, with a U.S. "wrap-around" containing: " appropriate securities, law legends and a recital of the restrictions on resale; " a discussion of the U.S. tax consequences of an investment in the shares; * in some cases, a discussion of the material differences between U.S. GAAP and the accounting principles used in the preparation of the issuer's financial statements; and " where the placement is being made on the basis of traditional procedures as opposed to Rule 144A, the form of non-distribution letter to be executed by each U.S. purchaser.227 The level of "due diligence" may also reflect foreign rather than U.S. standards. The underwriters in a private placement will have to decide early in the process whether they wish to engage in U.S.-style due diligence in connection with the drafting of the offering document - which might well be resisted by the issuer - or whether they are willing to accept the risks of proceeding on the basis of the practices that are customary in the issuer's home country, relying on the representations and indemnities given by the issuer with respect to the accuracy of the offering document. In particular, the underwriters will have to consider whether to ask counsel to provide a "10b-5 letter," which could add significantly to the costs of the offering. This decision will vary depending on a number of factors, including the size of the placement in the United States, the review process that is customary in the issuer's jurisdiction, the creditworthiness of the issuer, the legality and enforceability of the issuer's indemnity and the evolution of market practice following the Gustafson decision. 2 8 On the other hand, when the U.S. tranche is expected to represent a significant portion of the global offering as a whole, or is expected to be large in absolute terms, it is more likely that the offering document will be drafted with an eye to U.S. disclosure standards including for example, risk factors and MD&A - and that due dili227 Offers and sales in a U.S. private placement may also be made on the basis of research reports prepared by the underwriters, or without any marketing materials at all. Research reports may be used increasingly after the Gustafson decision, at least when the placement in the United States is relatively small. Gustafson, 115 S.Ct. at 1061 (1995). In larger placements, research reports, which often contain projections, may be used as a supplement to the more formal offering document. Any research report used in offering and selling the shares in the United States will be viewed as an offering document and will thus subject the underwriters, and possibly the issuer, to the same potential liabilities they have on the formal offering document. 228 See infra Part II.A.l.b. gence will be conducted on the basis of U.S. practices. A dilemma arises, however, when information about a company is simply not available. For example, many Russian companies do not currently have consolidated financial statements and accordingly are unable to present and analyze their results of operations and financial condition in ways that would meet customary standards for offering documents in the West. As a result, underwriters offering and selling shares of a Russian company in a U.S. private placement run the risk that they will be held liable for material omissions if an offering document is used in connection with the placement. Although underwriters are not permitted to disclaim liability under the U.S. securities laws, they should be able to reduce substantially the risk of liability for material omissions in connection with the offering in these circumstances if the limits on the availability and reliability of the information are fully disclosed, the underwriters engage in a significant due diligence exercise to ensure that the offering document is as accurate as it can be and that the risks are highlighted, and sales are made only to institutional investors with experience in investing in Russia or other emerging markets who execute letters acknowledging that they are capable of assessing the significance of the omissions and of bearing the risks involved. Finally, the international underwriters are even less likely than they would be when a U.S. public offering is involved to limit the research reports they distribute outside the United States to those that would be permitted by Rule 138 or 139 under the Securities Act. However, the prohibition on general solicitation, general advertising, and directed selling efforts in the United States will still require that steps be taken to ensure that research reports published abroad that do not comply with Rule 138 or Rule 139 do not flow into the United States.229 2. Restrictionson Market Activities The restrictions of Rule 10b-6 apply only when a "distribution" is being made in the United States. The term "distribution" means an offering of securities, whether or not subject to the registration requirements of the Securities Act of 1933, that is distinguished from ordinary trading transactions by the magnitude of the offering and the 229 The prohibition on general solicitation and general advertising may require that all research reports be excluded from the United States, and the prohibition on directed selling efforts may require that research reports other than those permitted by Rule 139(b) be excluded. See supra note 132. presence of special selling efforts and selling methods. 230 While a registered public offering of shares will constitute a distribution for purposes of Rule 10b-6 in virtually all cases, a private placement will only be a distribution in certain circumstances. Because the meaning of "distribution" is unclear, U.S. legal advisers in a global offering have often been unable to conclude that a particular private placement in the United States was outside its scope. Consequently, they often considered it necessary to approach the SEC in order to obtain assurances that the restrictions of Rule 10b-6 would not apply to the activities of participants in the offering outside the United States or to negotiate the terms of any passive market-making or other exemption. This need to approach the SEC staff obviated one of the principal benefits of the private placement route, which is the freedom to conduct the global offering without consulting U.S. regulators. More important, it jeopardized the timing of the offering, which would have been dictated principally by commercial realities and legal requirements outside the United States. Moreover, the kind of relief that could ultimately be obtained would likely be unacceptable to the issuer and other foreign participants in the offering because it would leave them with significant burdens on ordinary secondary market trading in the principal markets outside the United States, given that the only distribution in the United States was being made on a private basis to institutional investors and that no U.S. listing was being obtained. The SEC has done much to solve this problem. The significant exemptions granted to highly capitalized German, French and British companies discussed above in the context of U.S. public offerings apply as well when the U.S. distribution is made in a private placement. Global offerings by other companies may benefit from the important amendments to the Trading Rules adopted in May 1993. These amendments provide that the Trading Rules do not apply to a private placement, under Rule 144A or otherwise, of shares in a foreign company, so long as (1) offers and sales in the United States are made only to qualified institutional buyers or persons reasonably believed by the seller to be qualified institutional buyers; and (2) the shares are eligible for resale pursuant to Rule 144A.231 230 17 C.F.R. § 240.10b-6(c)(5). 231 17 C.F.R. § 240.10b-6(i), -7(o), -8(f). Offers and sales in the United States that are "offshore transactions" under Regulation S do not affect the availability of the exemption. Regulation S Transactions During Distributions of Foreign Securities to Qualified Institutional Buyers, SEC No-Action Letter, 1995 SEC No-Act. LEXIS 1039 (Feb. 22, 1994). Some problems do remain, however, for offerings by companies that do not fall within the German, French or U.K. exemptions. Many private placements provide for offers and sales both to qualified institutional buyers and to other institutional "accredited investors" (as defined in Regulation D under the Securities Act). The May 1993 amendments clearly do not apply to these so-called "side-by-side" placements. Moreover, the amendments do not apply to rights offerings that are conducted as private placements if the investors include persons other than qualified institutional buyers. In these rights offerings, however, an earlier exemption may come into play. Adopted on April 25, 1991, this exemption provides that the Trading Rules will not apply to non-U.S. trading activities in foreign securities during the period when rights or the underlying securities are being sold in the United States, so long as (1) offers and sales are made only to qualified institutional buyers or other institutional accredited investors; (2) the exercise price represents a discount of at least 8% from the market price of the underlying shares at the time the offering commences; and ( 3 ) the issuer has a public float of at least $150 million in voting securities. Further, the exemption is available only to underwriters and their affiliates, not to issuers and their affiliates. 3 2 In circumstances where no exemption is available, the U.S. legal advisers to the offering will either have to conclude that the selling efforts in the United States do not rise to the level of a distribution or seek specific relief from the SEC The factors to consider when deciding whether a particular placement in the United States constitutes a distribution include: " the size of the offering in the United States, both in absolute terms and in relation to the value of the issuer's publicly traded shares; " whether there is an identifiable U.S. underwriting syndicate and, if so, its size; * whether shares are allocated for sale in the United States; * the number of investors contacted in the United States; and * the nature of the selling efforts, including in particular whether a road show involving directors and officers of the issuer is being conducted. While this area is extremely murky, it would not be unwarranted for the participants in a global offering to proceed on the assumption that a U.S. placement will not be a distribution, regardless of its size, if: * it is limited to qualified institutional buyers and institutional accredited investors; 232 Securities Industry Association, SEC No-Action Letter, 1991 SEC No-Act. LEXIS 649 (Apr. 25, 1991). Northwestern Journal of International Law & Business * there is no identifiable U.S. syndicate; * no shares are allocated for sale in the United States; * the number of offerees is limited to one hundred; * the underwriters contact investors either by telephone or in very small groups; and * directors and officers of the issuer do not participate in the marketing efforts. If these conditions are not met, all the relevant facts and circumstances will have to be considered including the size of the placement, and in many cases the U.S. legal advisors may find themselves unable to reach a definitive conclusion. In those instances, the SEC's general relief regarding passive market-making, and the determination of the appropriate cooling-off period, may be relied on if they apply. If they do not apply, specific relief will have to be obtained. Members of the NASD are not obliged to obtain agreements from the international underwriters of the kind outlined above, since the rules in question do not apply in a private placement. The restrictions regarding a private placement of shares of a foreign investment company are outlined in part II.A.4, as are the limitations on the ability of foreign brokers or dealers to offer and sell securities to U.S. institutional investors. Global Equity Offering Involving Public Offerings in the United States and in other Countries" 3 The potential for conflict between the U.S. and foreign regulatory regimes is greatest when a global equity offering combines a public offering in the United States with a public offering in one or more regulated national markets abroad. Reconciling the various requirements in these circumstances, and obtaining relief from the appropriate regulatory authorities when the rules are irreconcilable, is a subtle and delicate task. While it is beyond the scope of this chapter to analyze the laws and regulations of countries other than the United States, the nature of some of the issues that can arise will be illustrated by discussion of recent global equity offerings in which U.S. public offerings were combined with public offerings in the United Kingdom, France, Germany, Italy and Japan. 233 Global equity offerings involving a public offering in both the United States and the countries referred to below are also discussed in [Edward F. Greene et al.] The U.K. privatizations of the 1980s and early 1990s combined public offerings in the United Kingdom and elsewhere with traditional U.S. private placements (Le., the U.K. water companies), U.S. private placements under Rule 144A (i.e., the U.K. electricity industry) and U.S. public offerings (i.e., British Airways plc, British Petroleum plc and British Telecommunications Plc (BT)). The structure and conduct of these global offerings was dictated in large measure by the commercial practices and legal requirements of the United Kingdom. Until the BT offering in late 1991, the U.K. privatizations followed a broadly similar pattern. Marketing would begin in the United Kingdom on "pathfinder day" with the publishing of the so-called "pathfinder prospectus." Several weeks later, on "impact day," the shares would be priced, the underwriting agreements would be signed, the U.K. prospectus in final form would be made available, and the subscription period would begin. Several weeks after that, on "allotment day," the shares would be purchased and dealings on the London Stock Exchange would commence. In the earliest privatizations, U.K. underwriters and sub-underwriters would be paid commissions for agreeing to take up any shares allocated to the U.K. offering for which subscribers were not found; over time, as HM Treasury gained confidence, the U.K. underwriters and sub-underwriters were gradually eliminated. It was considered essential in these privatizations that offers be made at the same time in all markets so as to prevent any underwriting syndicate from gaining a marketing advantage. It was also considered necessary to preclude "gray-market" trading of "when-issued" shares during the subscription period, since such trading could disrupt the U.K. marketing efforts. Moreover, the offering documents to be used in all markets were required to conform in substance to the U.K. pathfinder prospectus and final prospectus, and no changes in the substantive disclosure about the issuer or its business were permitted once the pathfinder prospectus was published. Finally, HM Treasury wished to retain complete discretion to decide whether the offering would proceed once the underwriting arrangements were put in place. These desiderata had significant implications for the registration process in the United States. First, while a registration statement could not be publicly filed with the SEC before pathfinder day, it was necessary to clear the preliminary prospectus with the SEC before that time, since no changes would be allowed thereafter, even in response to SEC comments. In order to ensure that the disclosure in the preliminary prospectus would not change, a confidential filing with the SEC was made sufficiently well in advance of pathfinder day to ensure that comments could be obtained and any required amendments could be reflected in all the offering documents, by pathfinder day. Secondly, in order to prevent flow-back into the United Kingdom, during the U.K. subscription period, of shares sold elsewhere, the underwriters were prohibited from confirming sales until allotment day. In the United States, this prohibition was strengthened by having the issuer request the registration statement to be declared effective only on allotment day, thus making it unlawful under §5(a) of the Securities Act for the U.S. underwriters to confirm sales in the United States before then. Finally, in order for HM Treasury to preserve discretion to decide whether the global offering would proceed, all conditions to the underwriters' obligations, including the effectiveness of the registration statement, and all termination rights, including customary force majeure provisions, were eliminated. This, combined with the long underwriting period covering the several weeks between impact day and allotment day, resulted in the underwriters assuming significant risks. In the United Kingdom, these risks could be shifted to sub-underwriters or institutional investors, who would give commitments on impact day in return for a share of the commissions. This option was not available to the U.S. underwriters, however, because obtaining commitments from sub-underwriters or institutional investors was considered the equivalent of confirming sales under the Securities Act, which was unlawful until the registration statement was declared effective. Accordingly, when the market crash of October 1987 occurred after impact day but before allotment day in the second British Petroleum offering, the U.S. underwriters took substantial losses. Two additional peculiarities of the standard U.K. privatization are worth noting. First, an over-allotment option generally was not provided and stabilizing activities were not contemplated. Secondly, intersyndicate transfers of shares were not permitted, except with the permission of HM Treasury. In the second BT offering, which was made in late 1991, HM Treasury introduced a number of significant innovations, which set the basic pattern for subsequent transactions. For the purposes , the most significant of these was the tender system, which was used by HM Treasury as a basis for pricing and allocating the shares. The system was designed to obtain three principal benefits: " to increase the "transparency" of the offering - i.e., to allow HM Treasury to look through the underwriters to see the actual interest in the shares of end-investors; " to allow pricing to occur just before allotment day rather than on impact day, thus permitting market developments that would otherwise be ignored to be taken into account; and " to shorten the underwriting period with a view to reducing commissions. Expanded from its somewhat peripheral role in the later stages of the privatization of the electricity industry where it was first tested, the tender system worked as follows: " On November 13, pathfinder day, the underwriters and HM Treasury executed the orderly marketing agreement, the pathfinder prospectus and other preliminary offering documents were published, and marketing began. " On November 21, impact day, the underwriters and HM Treasury executed the international tender offer agreement, HM Treasury determined the size of the discount from the tender offer price (to be decided later) that would be made available to U.K. individuals who subscribed for the shares, and the final U.K. prospectus was published. The international tender offer agreement obliged the underwriters to solicit indications of interest from investors in their markets, but did not oblige them to purchase any shares. " At the end of the day in London on Friday, December 6, the underwriters, through the managing underwriters in each of the ten syndicates, submitted bids on behalf of investors, indicating how many shares each investor wished to purchase and at what price. " Over the weekend of December 7-8, HM Treasury determined the number of shares to be allocated to each syndicate, with no syndicate being asked to purchase a number of shares in excess of the bids submitted on its behalf by its managing underwriter. If the managing underwriter for a syndicate accepted the number of shares that HM Treasury wished to allocate to it, and the price per share (which was to be the same for all syndicates), it would execute a purchase memorandum committing the syndicate to underwrite those shares. The purchase memoranda were held in escrow until the morning of Monday, December 9, when dealings commenced in London. In this framework, the U.S. preliminary prospectus was cleared with the SEC on a confidential basis in advance, the registration statement containing the preliminary prospectus was filed on pathfinder day, an interim amendment to the registration statement was filed on impact day, and an amended registration statement was filed and declared effective on Thursday, December 5, allowing the U.S. underwriters to confirm sales promptly after the price was set, and their underwriting obligations crystallized, on December 8. Thus, because the U.S. underwriters were free to sell the shares promptly after as Northwestern Journal of Internationa Law & Business suming their underwriting obligations, the risks they accepted in the offering were little different from those encountered in a standard U.S. underwriting. However, because the risks were much reduced from earlier privatizations - even to the point where there was some loose talk of the "elimination of underwriting" - the commissions were lowered to unprecedented levels, well below what is customary in the United States. There were two other innovative features in the BT offering which were significant for our purposes. First, an over-allotment option was provided and stabilization was contemplated for the first time in a global equity offering involving a public offering in the United Kingdom (the stabilizing activities being conducted under the SIB rules in accordance with the no-action position outlined above). Secondly, the SEC was persuaded to allow market-making by all the underwriters and their affiliates to continue on the London Stock Exchange in the ordinary course, without regard to the restrictions of Rule 10b-6 or the passive market-making requirements.1 4 Overall, the British experience represents a significant evolution toward U.S.-style underwriting. In recent transactions, the basic features of the 1991 BT offering have been refined but not fundamentally altered. The latest innovations have involved efforts to use allocation policies to control destructive market behavior by institutions - short selling in particular - before and during the subscription period. 2. France A global equity offering of shares in a French company also raises difficult questions of coordination, exacerbated by the fact that the French have less experience than the British in reconciling the conflicting commercial and legal requirements. A public offering in France involves, in principle, the issue of preferential subscription rights (droits pr~ftrentiels de souscription) that entitle existing shareholders to subscribe to newly issued shares in proportion to their existing holdings. The preferential subscription rights are detached from the existing shares on the day the subscription period begins in France and are immediately listed on the Paris Stock Exchange (and/or any 234 In addition, the U.S. underwriters were able to preserve in their agreement among underwriters the customary method of allocating selling commissions in the United States, which is to give the lead underwriter the authority to make sales for the accounts of the other underwriters and to allocate the selling commissions with respect to those sales as requested by the purchasers. This contrasted with the system that applied to most of the other syndicates, which required in effect that selling commissions be allocated among the underwriters pro ratato their underwriting commitments. local French stock exchange on which the issuer's shares may be listed). The listing remains effective throughout the subscription period, 23 5 which typically lasts for three weeks (twenty days is the minimum required by law). Preferential subscription rights may be waived by an extraordinary meeting of shareholders (assemblge gindrale extraordinaire)that authorizes the public offering. Such has been the case in a number of international equity offerings launched by French companies in the last few years. In these circumstances, however, the issue price of the newly issued shares may not be less than the average market price of the existing shares during twenty consecutive business days within the last forty business days preceding the commencement of the offering. Furthermore, the Commission des Operationsde Bourse (COB) may insist that the issue price of the new shares be as close as possible to the market price of the existing shares at the time of the pricing of the new shares, particularly if the market price of the existing shares has been increasing in the recent past. An offering predicated on a waiver of preferential subscription rights may therefore prove commercially unfeasible, as the so-called "twenty-forty rule" and the COB's requirements may severely affect the pricing and limit the discount at which the new shares may be offered. In addition, the COB is not in favor of waivers of preferential subscription rights, which in its view may put smaller shareholders at a disadvantage. In order to mitigate this disadvantage and be responsive to the COB's concerns, it is customary for French issuers, when preferential subscription rights are waived, to grant their existing shareholders priority rights (droits de priorit6) to subscribe on a pro ratabasis to the newly issued shares. Unlike preferential subscription rights, priority rights are neither listed nor negotiable and usually cover a shorter period of time (typically around ten business days). Under French law, the terms of a public offering, including in particular the price of the shares, cannot be made public until they are announced in the Bulletin des Annonces L~gales Obligatoires (BALO), which must occur at least six days prior to the beginning of the subscription period in France. If this limitation were to apply to the offering being made in the United States, there would be no opportunity for marketing to commence on the basis of a preliminary prospectus, as is customary in a U.S. public offering. Moreover, it is unlikely that the participants in the French offering would allow sales 235 For practical reasons, it is customary to extend the listing of the preferential subscription rights until two days after the end of the subscription period. Northwestern Journal of International Law & Business to be confirmed in the United States until the end of the subscription period in France, since gray-market trading of shares bought in the United States on a when-issued basis could prove disruptive. Thus, the risks for the U.S. underwriters would be similar to those in a U.K. privatization before the 1991 BT offering. These issues were identified, and resolved in a highly satisfactory way, in the global offering of shares in Soci6t6 Nationale Elf Aquitaine (Elf) in the early summer of 1991. In that offering, the COB permitted the offering to proceed without any priority or preferential subscription rights for existing shareholders, which allowed sales to be confirmed in the United States immediately after pricing since there was no need to wait for the end of a subscription period in France. In addition, the COB permitted marketing in the offerings outside France, including in the public offering in the United States, to begin in advance of the pricing announcement in the BALO on the basis of a preliminary prospectus that, as is customary, would omit pricing information. Finally, simultaneous trading in Paris and New York was facilitated by quoting promesses d'actions (rights to acquire shares, akin to "when issued" shares) on the Paris Stock Exchange at the same time as trading began on the New York Stock Exchange. This resolved the inconsistency between U.S. and French practices deriving from the fact that trading in the United States normally begins immediately after pricing while in France it would not commence until closing. The global equity offering of Euro Disney in the spring of 1994 was conducted quite differently. It involved the issue of preferential subscription rights, which allowed the newly issued shares to be offered at a discount to the market price and also allowed the existing shareholders either to exercise these rights or sell them in the market. For technical reasons, the offering was also registered with the SEC in the United States. As a result of secondary market trading after Euro Disney's initial public offering in 1989, the issuer was unable to conclude that its shareholder base in the United States was limited to qualified institutional buyers and other accredited investors and thus that a U.S. private placement could be conducted. Moreover, as French law requires that preferential subscription rights, if issued, be issued to all shareholders, U.S. shareholders could not be excluded from the offering. Accordingly, the offering was required to be registered with the SEC The United States, was not expected to be a significant focus of the offering, however. Accordingly, no particular efforts were made to facilitate the purchase of the newly issued shares by U.S. shareholders or other U.S. investors. The Euro Disney shares were not listed in the United States before or after the global offering and an ADR program was not put in place. Although an information agent was appointed in the United States, no mechanism was provided to help U.S. investors or their brokers to convert U.S. dollars into French francs in order to pay the purchase price of the shares or to protect them against foreign exchange risks incurred as a result of such conversion. Moreover, no mechanism similar to the one implemented by Elf in order to permit trading of the new shares on a when-issued basis immediately after pricing was implemented: the shares were delivered on August 12,1994 and listed in Paris on August 17, 1994, more than one month after the closing of the subscription period and over two months after pricing. Germany Substantial issues of coordination arise in a global offering involving shares of a Germany company. As in France, there is little experience in reconciling inconsistent practices, as only one German company, Daimler-Benz AG (Daimler), has to date made public offering of its shares in the United States as part of a global offering. German public offerings are generally conducted as offerings of subscription rights to existing shareholders.23 6 German rights offerings are structured as so-called "clawback" rights offerings, in which the underwriting syndicate purchases all of the new shares to be issued in the rights offering from the issuer prior to the commencement of the subscription period. Exchange trading in the rights may take place throughout the subscription period, which, in the case of Daimler, lasted two weeks. The price of the shares to be offered is fixed well prior to the commencement date for the rights offering (permitting the issuance of the new shares to be entered into the commercial register on the basis of the subscription, therefore, by the syndicate members) and typically includes a steep discount (up to twenty percent). The syndicate members may purchase and sell rights in the market during the subscription period and then, upon the expiration of the subscription period, may commence offering any unsubscribed 236 German corporate law makes it difficult for a German company to increase its capital other than by offering rights to existing shareholders. One new exception to the general rule permits companies to increase their capital by up to ten percent without being required first to offer the new shares to existing shareholders. This exception is likely to make it easier for German companies to offer relatively small amounts of shares in the United States and elsewhere outside Germany in a manner that conforms more closely to the practices in the jurisdictions in which such offerings are made. shares remaining in their possession to new investors in Germany and abroad. This structure presents significant risks for syndicate members, who, in the case of Daimler, were exposed to price fluctuations and other market risks for nearly one month (albeit with the significant cushion provided by the offer discount). Marketing took place in the United States in the Daimler offering on the basis of a preliminary prospectus, dated the day after the price was established, that included the pricing information. Effectiveness was delayed until immediately before the commencement of the subscription period for the new shares; in order to prevent market disruption in Germany, it was important to the syndicate members to preclude trading of rights or new Daimler shares on a when-issued basis prior to the commencement of the subscription period. Other reconciliation issues that arose in the Daimler offering involved the disclosure of certain details relating to the underwriting arrangements. The actual underwriting agreement in a German offering is not a matter of public record; even underwriters other than the lead underwriter do not normally have access to the underwriting agreement other than in summary form with respect to the information affecting them individually. Even allocations among the underwriters are generally treated as confidential by the issuer and the lead underwriter. This practice is inconsistent with the U.S. requirement that the underwriting agreement be filed as an exhibit to the registration statement and that detailed disclosure relating to the underwriting arrangements (including allocations to underwriters and the underwriters' compensation arrangements) be made. In the case of Daimler, the underwriting agreement was in fact filed as an exhibit to the registration statement, but certain of the details relating to the commission structure and viewed as more highly sensitive were redacted out of the document filed. The allocations among the underwriters were disclosed, however 4. Italy Until the global offering by the Italian Treasury (and other smaller shareholders) in early 1994 of shares in Istituto Mobiliare Italiano S.P.A. (IMI), the Italian regulatory framework and market practice would effectively have made it impossible to conduct an initial public offering with simultaneous listing and trading on Italian and non-Italian stock exchanges. The IMI global offering had three tranches: a domestic public offering, a U.S. public offering and an institutional offering, both domestic and international. Public offers of securities may be made in Italy only on the basis of a prospectus filed with the CommissioneNazionaleper le Societd e la Borsa (CONSOB). CONSOB regulations require that the prospectus be filed at least five days before the beginning of the subscription period, stating the quantity and, in the case of initial public offerings, also the price of the securities being offered for sale (only in the case of offerings of securities of a listed company is it possible to announce the price no later than the day before the start of the subscription period). No solicitation may take place until the prospectus is published. The practice and the regulations do not contemplate the filing and publication of a preliminary prospectus on the basis of which marketing activities may begin. Moreover, the usual timing of the admission to listing and beginning of trading, as determined by CONSOB regulations, would create a further conflict with the timing of an offering in international markets. As a prerequisite for admission to listing in Italy, shares must have a "sufficient distribution" (Le., in principle no less than 25 percent of a given class of shares and 500 shareholders). As a rule, in the case of an initial public offering, the CONSOB does not set the date for the beginning of trading until it has ascertained that a sufficient distribution has been made, upon receipt from the issuer of detailed information on the number of investors and of shares sold and a declaration that the shares have been delivered to the investors. This procedure normally takes ten to twenty days. Furthermore, trading may not begin until five days have elapsed from the publication of a notice announcing the date set by the CONSOB for the beginning of trading. In response to IMI's requests aimed at coordinating the timing of the domestic and international offerings, the CONSOB granted IMI extensive relief from, or formally amended, a number of its rules, thus permitting all key stages of the offering to be conducted simultaneously in Italy and abroad. The U.S. and international preliminary prospectuses and the Italian prospectus were published on the same day, approximately three weeks before pricing, including only a range for the number of shares and the price of the shares in the Italian public offering. Thus, marketing and book-building activities could take place simultaneously in Italy and abroad. The pricing of the Italian offering, sizing of the global offering and execution of the underwriting agreements were permitted to take place just two days before the Italian subscription period was due to open, on Saturday, January 29, and a notice completing the terms of the Italian offering was published the following day in the Italian press (the notice did not fix, however, the exact size of the Italian offering, since the CONSOB allowed the Treasury to maintain discretion to reallocate shares among the three tranches of the global offering). The subscription period commenced on Monday, January 31, and was due to last five days. It was closed on February 1, after only two days, as the offering was heavily over-subscribed. Moreover, CONSOB introduced a new section (18bis) to its Regulation No. 4088/1989 on admission to listing and trading, applicable only in the case of a simultaneous equity offering in Italy and abroad, permitting trading to begin in Italy essentially on a "when issued basis" (i.e., waiving the requirement that shares be issued to the investors before trading could begin and requiring only that the domestic underwriters commit to completing the allocation procedures and be in a position to confirm sales on the first day of trading). Unlike the COB in France, however, the CONSOB required that the U.S. and international underwriters undertake not to allow a gray market to develop abroad; the underwriters were not permitted to confirm sales outside Italy before trading started in Italy. As a result of these rules, the market risk borne by U.S. and international underwriters was reduced to the period of seven business days from pricing to confirmation. On February 7, the CONSOB confirmed, on the sole basis of the total number of shares allotted to the Italian public offering, that the offering had achieved a sufficiently wide distribution in Italy and that, as a consequence, trading could begin the day after a notice of its decision was published (publication occurred the following day). On February 8, the U.S. registration statement was declared effective. On February 9, the eighth business day after pricing, trading commenced simultaneously on the Sistema Telematico delle Borse Valori Italiane (the Italian screen-based stock exchange) and New York Stock Exchange. The CONSOB initially took the position that an over-allotment option would conflict with the Italian legal and regulatory provisions that require the maximum size of public offering in Italy to be determined in advance. This objection was overcome, however. The selling shareholder was permitted by the CONSOB to reallocate to the Italian public offering a number of shares initially offered in the two other tranches of the global offering. The shortfall in the other tranches could then be filled through the exercise of an over-allotment option (exercisable within thirty days of the effective date of the U.S. and international prospectuses and limited to 15 percent of the institutional and U.S. public offering tranches). 5. Japan In Japan, a foreign company wishing to offer equity to the Japanese public was, until 1989, required, as a practical matter, to obtain a listing on the Tokyo Stock Exchange. Since that exchange's listing criteria are stringent, and the listing process is time-consuming and expensive, many foreign issuers had been deterred from raising capital in Japan's public markets and had relied instead on a private placement exemption23 7 or secondary sales when offering securities to Japanese investors.23 In 1989, procedures doing away with the Tokyo listing requirement were put into effect. These procedures make it easier for foreign companies to offer shares in a public offering in Japan, particularly in connection with a global offering involving a public offering in the United States or in another national market. For a company to be able to use these procedures to conduct a "public offering without listing," its stock must be listed on its home stock exchange (which must be an exchange approved by the Japanese Securities Dealers Association). 239 Under the procedures for public offerings, the precise number of shares to be offered in Japan generally must be registered before sales can be confirmed, and a securities registration statement in Japanese must be declared effective by the Ministry of Finance pursuant to the Securities and Exchange Law of Japan. In terms of substance, a U.S. registration statement or U.K. listing particulars can easily be converted into a Japanese registration statement. As a general matter, the registration statement cannot be declared effective and sales may not be confirmed until the second Tokyo business day after an amendment to the registration statement setting forth the price of the shares has been filed. In the past, the Ministry of Finance has relaxed this requirement on an ad hoc basis for global offerings.2 40 Regulatory 237 In Changes in the Japanese Securities and Exchange Law effected in 1993 clarified the use of private placements in Japan, and specifically permit private placements of newly issued equity securities to less than 50 persons without requiring the filing of a registration statement with the Ministry of Finance. 238 Secondary sales include sales of shares that are purchased by underwriters in primary offerings outside Japan and then resold in Japan through Japanese brokers on the day after the closing. 239 In 1994 these exchanges, which had been limited to the exchanges of OECD countries, were expanded to include non-OECD country exchanges that have disclosure requirements sufficient for the protection of investors, as determined by the Japanese Securities Dealers Association. 240 For example, in the offering by Compafiia de Tel~fonos de Mexico (Telmex), the Ministry of Finance allowed sales to be confirmed on the first business day after that filing. changes that became effective in 1994, however, allowed pricing amendments to a registration statement to be declared effective on the first Tokyo business day after they are filed in circumstances where the underwriters obtain indications of interest in the offering during a marketing period in which a preliminary prospectus is used (i.e., through a book-building process). Beginning in July 1995, the Ministry of Finance will declare a pricing amendment effective on the same day it is fied when a book-building process is involved. 241 These changes greatly reduce the risk to the Japanese syndicate in a global offering associated with the time lag between trading in Japan and trading in markets located outside Japan. In a global offering that includes a public offering in Japan, transfers of shares to or from the Japanese syndicate are generally not possible, nor is it possible for the Japanese syndicate to participate in an over-allotment option, due to the requirement that the precise number of shares to be offered in Japan be registered with the Ministry of Finance at the time the registration statement is declared effective. In the 1991 Telmex offering, however, the Ministry of Finance permitted the use in Japan of an over-allotment option so long as the Japanese syndicate controlled whether the option would be exercised by the Japanese syndicate, the registration statement covered the maximum number of shares to be offered and sold in Japan (including the shares that would have been sold upon the exercise of the option) and the settlement date for the shares subject to the option was the same as the settlement date for the other shares.242 IV. CONCLUSION As the world's capital markets become more integrated, global offerings of shares are likely to remain the preferred way for governments to privatize their state-owned companies and industries, and for 241 In the case of Japanese issuers, the offering price is often calculated in accordance with a specific formula. If the formula is disclosed in the original registration statement, sales can be confirmed immediately after the registration statement is declared effective (which generally takes place 14 days following the original filing). While an amendment disclosing the actual price is required to be filed even where the pricing formula is disclosed in the original filing, the filing of such an amendment is not a precondition to confirmation of sales. 242 Under a normal over-allotment option, the global coordinator decides whether to exercise the option and allocates the shares on a pro ratabasis to each syndicate, subject to inter-syndicate transfers pursuant to the orderly marketing arrangements. The settlement date for the shares subject to the option may also be later than the settlement date for the shares in the initial offering. The Ministry of Finance has thus far not permitted use of this standard type of overallotment option in Japan. world-class private issuers to raise equity capital. Two kinds of developments can be anticipated: " commercial innovations, which among other things may involve efforts to increase "transparency," improve pricing mechanisms and reduce commissions, perhaps following the path broken by HM Treasury in the recent U.K. privatizations; and " coordination among regulatory authorities, which will harmonize many of the conflicting requirements of the legal regimes of the principal countries where offerings are generally made. While commercial innovations are difficult to anticipate, the main lines of regulatory coordination, at least in so far as the U.S. authorities are concerned, can now be seen. First, the SEC will probably continue to refine its thinking about the application of the Trading Rules to foreign trading activities. Not only will the SEC create further exemptions for offerings by highlycapitalized foreign companies, but it is likely to change the Trading Rules in their entirety along the lines of proposed Regulation M. Second, the SEC has proposed the adoption of rules permitting certain kinds of offerings - i.e., exchange offers and rights offerings when only a small proportion of the shares in the company in question is held in the United States - to be made in the United States on the basis of the offering documents that are used in the issuer's home market, without requiring additional disclosures (including in particular with regard to the issuer's financial statements). Although proposals on these matters have been made, they have not yet been adopted. 43 The principal purpose of relaxing the U.S. requirements in these kinds of offerings is to allow U.S. shareholders to take advantage of opportunities they would otherwise be denied. Under the current system, U.S. shareholders are often excluded because of the issuer's unwillingness to comply with SEC requirements, because doing so could require additional disclosure, involve additional costs and potential liabilities, and subordinate the timing of the offering to the SEC registration process. Finally, the SEC is exploring ways in which other kinds of public offerings can be made in the United States on the basis of "home country disclosure." The most fruitful approach thus far has been to establish reciprocal arrangements with foreign regulatory authorities whereby certain classes of companies in each country are permitted to offer securities in the other country on the basis of the disclosure re243 Securities Act Release No. 6898, Exchange Act Release No. 29277, 17 Fed. Reg. 229, at 240,249 (June 6, 1991) deals with exchange offers, while Securities Act Release No. 6896, 56 Fed. Reg. 27,564 (June 14, 1991) covers rights offerings. quirements of the home market. These arrangements have been established with Canada and comparable arrangements may now be considered for other countries. More likely, however, is the continued dialog between the regulators of different countries over incremental changes to accounting principles and financial statement requirements, which in the end form the basis of all disclosure. 3.


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Daniel A. Braverman. U.S. Legal Considerations Affecting Global Offerings of Shares in Foreign Companies, Northwestern Journal of International Law & Business, 1996,