Uninvited U.S. Investors? The Explosion of Unsponsored ADR Programs and the Implications for Foreign Private Issuers

Last week we reported that the U.S. Security and Exchange Commission’s (“SEC”) eagerly awaited amendments to Rule 12g3-2(b) became effective on October 10, 2008. The new Rules automatically exempt foreign private issuers from the registration requirements of Section 12(g) of the U.S. Exchange Act of 1934, provided certain conditions are met.

One anticipated concern of foreign private issuers, as a result of the automatic nature of the new exemption, was the potential proliferation of unsponsored ADR programs. This concern appears to have been justified. From September 1, 2008 to October 9, 2008, the SEC’s records show 49 filings for sponsored and unsponsored ADR programs. Since the commencement of the new 12g3-2(b) Rules on October 10, 2008, the SEC’s records show that the large ADR banks have filed in excess of 400 new unsponsored ADR programs. This release outlines the implications for foreign private issuers who find that a depositary bank hás created an unsponsored ADR program over its securities without its consent.

The Problem

The SEC, when it published its proposals to amend the prior Rule 12g3-2(b) exemption, recognized that additional unsponsored ADR programs may result from an automatic exemption replacing the written application necessary to secure Rule 12g3-2(b) exemption. It noted that under the prior Rule 12g3-2(b) a foreign private issuer that does not seek to have its securities traded in the United States in the form of ADR’s is able, by not formally claiming the Rule 12g3-2(b) exemption and submitting documents to the SEC, to restrict the ability of ADR depositary banks to establish an unsponsored ADR facility.

Once the exemption became available without the need to file an application, an issuer’s ability to control the establishment of an unsponsored ADR program was lost. In light of the possible proliferation of unsponsored ADR programs, the SEC specifically solicited comments on the question of whether, as a condition to the registration of ADRs, the issuer must give its consent to the depositary and whether the depositary must notify the foreign private issuer of its intention to register ADRs and have either received an affirmative statement of no objection from the issuer or not received an affirmative statement of objection from the issuer.

In the final Rules the SEC acknowledged the competing interests of the depositary banks and foreign private issuers. However, the SEC chose to ignore the various measures suggested to protect issuers.

Instead, the SEC sided with the depositary banks and included a suggestion that the depositary banks be able to establish unsponsored ADR programs based upon their reasonable, good faith belief, after exercising reasonable due diligence, that an issuer complies with the new Rule 12g3-2(b).

Interestingly, the SEC made reference to the submission made by one of the large depositary banks, Deutsche Bank, who stated that, because, in practice, depositary banks typically obtain the issuer’s consent before establishing an unsponsored ADR facility, a rule requiring such consent was not necessary.

It is apparent from the increased level of filings with the SEC that the unsponsored ADR environment is becoming less friendly than that suggested by Deutsche Bank, and that depositary banks are proceeding to establish unsponsored ADR facilities without the consent of the issuer.

Implications for Foreign Private Issuers

The existence of an unsponsored ADR program may cause problems should a foreign private issuer subsequently choose to establish its own ADR program. It is well established that a depositary bank may not implement an unsponsored ADR program where a sponsored ADR program already exists. The position when no sponsored program exists is more complicated. It was suggested to the SEC that the new Rules require a depositary bank to terminate an unsponsored facility created without the consent of an issuer if the issuer decides to create a sponsored facility. This suggestion was rejected.

The problem arises from the fact that the SEC will not permit an unsponsored facility to co-exist with a sponsored facility for the same deposited securities. An issuer seeking to establish a sponsored facility after the establishment of an unsponsored ADR facility, is required to ensure that the depositary of the unsponsored facility would effect a transfer of the deposited securities and the related ADR holders to the new sponsored facility and terminate the unsponsored facility.

In addition, the SEC hás stated that the depositary bank and the issuer, when filing to establish a sponsored ADR program, will be required to provide a representation that arrangements are in place to terminate any existing unsponsored ADR programs in a prompt and orderly fashion. The SEC may require written confirmation from the depositary of the unsponsored program that it agrees with such arrangements. This provides the incumbent unsponsored depositary bank with the technical legal ability to preclude a company from instituting a sponsored ADR program and thus leverage regarding the identity of the depositary bank for the proposed sponsored facility.