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A Lesson in ADR and SOX Comparative Intl. Labor Relations By: S. Carpenter, A. Caccamo, and K. O’Brien What is an ADR? American Depositary Receipt (ADR) A stock that trades in the U.S. but represents a specific number of shares in a foreign corporation Bought and sold on American markets

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a lesson in adr and sox

A Lesson in ADR and SOX

Comparative Intl. Labor Relations

By: S. Carpenter, A. Caccamo, and K. O’Brien

what is an adr
What is an ADR?
  • American Depositary Receipt (ADR)
  • A stock that trades in the U.S. but represents a specific number of shares in a foreign corporation
  • Bought and sold on American markets
  • Issued/sponsored in the U.S. by a domestic bank or brokerage
history of adr
History of ADR
  • Introduced to the financial markets in 1927
  • Result of: (1) complexities in buying shares in foreign countries and (2) difficulties with trading at different currency values
  • U.S. banks purchase bulks of shares from the foreign company, bundle the shares into groups, and reissue on the NYSE, AMEX or the Nasdaq
  • In return, foreign company must provide detailed financial information to the sponsor bank
  • The depositary bank sets the ratio of U.S. ADRs per home-country share; this ratio can be anything less than or greater than 1
  • Majority of ADRs range between $10 and $100 per share
pricing example
Pricing Example
  • Russian Vodka Inc. wants to list shares on the NYSE to gain exposure to the U.S. market and to tap into the growing demand for vodka
  • Russian Vodka already trades on the Russian Stock Exchange at 127 Russian roubles (equivalent to US$4.58)
  • A U.S. bank purchases 30 million shares from Russian Vodka Inc. and issues them in the U.S. at a ratio of 10:1. This means each ADR share you purchase is worth 10 shares on the Russian Stock Exchange
  • The new ADR should have an issue price of around US$45.80 each (10 times $4.58)
three types of adrs
Three Types of ADRs
  • Level 1: Foreign companies either don't qualify or don't wish to have their ADR listed on an exchange
    • over-the-counter market
    • loosest requirements from the SEC
  • Level 2: Listed on an exchange or quoted on Nasdaq
    • slightly more requirements from the SEC
    • higher visibility trading volume
  • Level 3: Issuer floats a public offering on U.S. exchange
    • able to raise capital and gain substantial visibility in the U.S. financial markets
benefits of adrs
Benefits of ADRs?
  • For individuals, ADRs are an easy, cost-effective way to buy shares in a foreign company
  • Foreign entities like ADRs because they get more U.S. exposure, allowing them to tap into the wealthy North American equities markets
risks of adrs
Risks of ADRs
  • Political Risk
    • Is the government of the ADR’s home country stable?
  • Exchange Rate Risk
    • Is the currency of the home country stable?
  • Inflationary Risk
    • Extension of exchange rate risk
what is sox
What is SOX?
  • Sarbanes-Oxley Act of 2002 (also: Public Company Accounting Reform and Investor Protection Act of 2002)
  • US Federal law enacted in response to a number of major corporate and accounting scandals
background on sox
Background on SOX
  • Applies new standards for all U.S. public company boards, management and public accounting firms
  • Does not apply to privately held companies
  • Act contains 11 Titles and requires the SEC to implement rulings on requirements to comply with the new law
11 titles in sox
11 Titles in SOX
  • Public Company Accounting Oversight Board (PCAOB)
  • Auditor Independence
  • Corporate Responsibility
  • Enhanced Financial Disclosures
  • Analyst Conflicts of Interest
  • Commission Resources and Authority
  • Studies and Reports
  • Corporate and Criminal Fraud Accountability
  • White Collar Crime Penalty Enhancement
  • Corporate Tax Returns
  • Corporate Fraud Accountability
effect on non us companies
Effect on Non-US Companies
  • Depends if country is developed/well-regulated or less developed
    • i.e. poorly regulated countries – benefit from better credit ratings by complying to regulations; developed countries – incur costs
  • Displaces business from NY to London
  • Alternative Investment Market claims that its growth in listings almost entirely coincided with SOX legislation
praise of sox
Praise of SOX
  • Improved investor confidence and more accurate, reliable financial statements
    • "Sarbanes-Oxley helped restore trust in U.S. markets by increasing accountability, speeding up reporting, and making audits more independent.“ – SEC Chairman Christopher Cox, 2007
  • Auditor conflicts of interest have been addressed - prohibits auditors from having lucrative consulting agreements with the firms they audit
  • Improved investor confidence in financial reporting; improvements in board, audit committee, and senior management engagement in financial reporting; improvements in financial controls
criticisms of sox
Criticisms of SOX
  • Reduced America's international competitive edge against foreign financial service providers, by introducing a complex and regulatory environment into U.S. financial markets
    • Following the act's passage, smaller international companies were more likely to list in stock exchanges in the U.K. rather than U.S. stock exchanges (Journal of Accounting Research, 2008)
  • Overall reluctance of small businesses and foreign firms to register on US stock exchange
    • “These regulations are damaging American capital markets by providing an incentive for small US firms and foreign firms to deregister from US stock exchanges” – Ron Paul
how sox regulates adrs
How SOX Regulates ADRs
  • Level 1 ADRs do not have to have to comply with SOX
    • Not registered with the SEC
  • Level 2 and Level 3 ADRs must comply with SOX
    • Can be costly for a company beginning a U.S. ADR Program
    • Costs include a significant intangible cost: diversion of senior management time
compliance with sox
Compliance with SOX
  • Establish a full-time investor, or investor relations team, based in the U.S.
  • Senior executives must visit institutional investors and securities analysts at least twice a year, if not more
the future of sox and adrs
The Future of SOX and ADRs
  • Currently, interest by foreign companies to have shares traded in the U.S. is on rise because of two new SEC rules
    • Japan, Hong Kong, and Australia
  • Companies are not looking to list on NYSE or Nasdaq
    • Want to set up Level 1 ADRs and trade over the counter (OTC)
  • Two Rules:
    • Automatic exemption from listing on SEC
    • Brokers must report trades within 90 seconds and information on each trade must be available in real time
      • Will make pricing more transparent
the end

The End

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