Shearman & Sterling
Fax: 212-848-7179 599 LEXINGTON AVENUE Abu Dhabi
212-848-7181 NEW YORK, N.Y. 10022-6069 Beijing
Telex: 667290 WUI (212) 848-4000 Budapest
May 17, 1999 New York
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
International Disclosure Standards, Proposed Rulemaking,
Release Nos. 33-7637; 34-41014
(Feb. 2, 1999) (File No. S7-3-99)
Dear Mr. Katz:
We welcome the opportunity to comment on the issues raised in the captioned release. We support the efforts of the Securities and Exchange Commission to promote the convergence of disclosure standards internationally and commend the leadership the Commission and Commission staff have provided in achieving this international initiative. Convergence of national disclosure requirements to a high level international standard would greatly benefit issuers and investors alike. However, we believe SEC adoption of the standards proposed by the International Organization of Securities Commissions (IOSCO) on a mandatory basis at this time will not accomplish the Commission=s goals of lowering costs for non-U.S. issuers and increasing U.S. investors= investment opportunities, but rather may deter cross-border listings and offerings into the United States. As proposed, the IOSCO disclosure standards would impose additional costs and compliance burdens for non-U.S. issuers accessing the U.S. public
market. Adding further disclosure obligations to the existing requirements of Form 20-F will only heighten the differences between home country and U.S. standards and thereby increase compliance burdens. Non-U.S. companies also are likely to find the rescission of the recent amendments to Rule 3-19 that were intended to accommodate home country reporting practice and to allow non-U.S. companies the full benefits of shelf registration troubling, not only because of the added compliance burden but even more significantly because of the perceived retreat from the Commission=s policy of constructive accommodation. We also have concerns with several specific provisions that the release proposes for adoption.
Proposal to Make IOSCO Standards Mandatory
We do not believe that the United States should adopt the IOSCO disclosure standards for foreign private issuers on a mandatory basis. Rather, we believe that the Commission can substantially further its goal of fostering convergence by adopting the IOSCO disclosure standards on an elective basis. The United States is already perceived as having the most demanding disclosure requirements in the world. Imposing yet stricter disclosure standards in the name of international harmonization will only serve to magnify that perception and discourage foreign private issuers= entry into the U.S. public markets. As the Commission has learned over the years, every new requirement has the potential to strengthen the disincentives to enter the U.S. market. Absent adoption and implementation by other major markets of at least comparable requirements for domestic as well as cross-border listings and offerings, the Commission will be perceived as increasing, rather than "reducing," the barriers to cross-border offerings and listings. In our experience, comparability to home country requirements is far more important to non-U.S. companies considering entry into the U.S. market than the comparability of U.S. standards to those of other non-domestic markets. Thus, even if all other major markets of the world were to implement the IOSCO standards for cross-border listings and offerings, the fundamental question will be whether the non-U.S. company is prepared to comply with the additional disclosure and accounting required to engage in cross-border public financings, or whether it should rely on cross-border private placements.
The Commission reiterates its policy, articulated in 1988, that "[t]he goal in addressing international disclosure and registration problems should be to minimize regulatory impediments without compromising investor protection." We question whether any real investor protection purpose will be served by having the U.S. tighten what are already comparatively rigorous standards without other major markets adopting a comparable regime for domestic as well as cross-border listings and offerings. U.S. investors will realize meaningful benefits only if the new requirements do not push non-U.S. issuers into the U.S. private or offshore markets.
The Commission can serve a leadership role in furthering convergence around the IOSCO disclosure standards by adopting such standards as an elective alternative to the current Form 20-F. Foreign private issuers would, thus, be free to comply with either the current Form 20-F or the IOSCO disclosure standards. The convergence of disclosure standards applicable to
cross-border listing and offerings should ultimately reduce costs for those issuers that conclude, for economic and other reasons, to enter foreign public markets. This would be particularly true if markets, particularly emerging markets whose standards may not be as rigorous, adopted the IOSCO standards as their own.
As noted by the Commission, a two-tiered system in which continued compliance with the current Form 20-F would depend on whether the United States were the only non-domestic public market an issuer chose to access would be unduly complicated. If the Commission adopts the IOSCO disclosure standards on an elective basis, an election to continue with the existing Form 20-F or use the alternative IOSCO-based form should not be subject to any condition. Thus, for the benefit of U.S. investors and the U.S. capital market and consistent with IOSCO=s approach of encouraging acceptance of the standards, we recommend that the current Form 20-F be left unchanged and that foreign private issuers be given the option to conform their disclosure documents to an alternative version incorporating the IOSCO disclosure standards. Issuers who believe that the burden of complying with the IOSCO disclosure standards will be offset by the benefits that the use of such standards provide will voluntarily comply with them. Making compliance elective would constitute a good market test of the extent to which adoption actually produces efficiencies for companies. Moreover, by taking this step of recognizing the IOSCO standards, the Commission would achieve a significant part of its goal of encouraging other jurisdictions to adopt them.
The proposing release did not contain a detailed discussion of the impact of the proposed revisions on each of the current requirements in Form 20-F, which made it difficult to assess the full impact of the proposal. If the Commission determines to adopt the IOSCO disclosure standards either on an elective or mandatory basis, it is critical that it clearly identify what additional or different disclosures are required by each revision as well as those revisions that are not intended to require different disclosure than that currently called for by Form 20-F.
Many foreign private issuers who have entered the U.S. public market relied on disclosure accommodations provided by the Commission in recognition of offshore disclosure practicesCmost significantly those related to executive compensation and related party transactions, as to which the Commission has recognized home country practices. The proposed revisions appear to eliminate reliance on home country disclosure practice in the case of related party transactions, which is likely to be of substantial concern to a number of current non-U.S. registrants. Moreover, the proposals would require the more than 1,000 existing registrants to recast their current Forms 20-F and undertake a detailed, burdensome review of the new requirements to ascertain whether any of the changes require additional or changed disclosure.
If the Commission decides, nonetheless, to adopt the IOSCO disclosure standards on a mandatory basis, we recommend, at a minimum, that companies that have already subjected themselves to reporting under the Exchange Act be grandfathered.
Proposal to Modify Rule 3-19 of Regulation S-X
Rescission of the 1993 revisions to Rule 3-19 to impose expedited updating of financial statements in Securities Act registration statements will impose additional costs on foreign private issuers and disrupt their ability to take full advantage of shelf registration. It would reintroduce "black-out" periods and exacerbate the burdens of U.S. GAAP reconciliation by forcing foreign private issuers to produce reconciliations of their financial statements in significantly shorter time periods.
The Commission explicitly recognized the problem of black-out periods in 1993 when it last amended the rules relating to the age of financial statements of foreign private issuers. See SEC International Series Rel. No. 605 (Nov. 3, 1993). The amendments were intended to provide foreign private issuers the full benefit of shelf registration by eliminating such black-out periods. The amendments made the age of financial statements required in connection with offerings registered under the Securities Act correspond to the requirements of annual disclosure imposed by the Exchange Act. The ten-month updating requirement was implemented "to reduce the impediments to foreign issuers making securities offerings in the United States," "conforming such requirements to the financial statement updating requirements of the home jurisdictions of a substantial majority of foreign issuers." Id. The Commission recognized then that despite its "determination not to impose any interim periodic reporting requirements on foreign private issuers, the effect of [its] age of financial statement provisions ha[d] been that a foreign private issuer [was required to] provide interim financial information more frequently than semi-annually if it wishe[d] to conduct continuous offerings without interruption and to avoid delays in commencing a registered offering." Id.
The proposed reintroduction of black-out periods would cause unnecessary and costly delays for many issuers and seriously disrupt the benefits of shelf registration. Issuers in jurisdictions with semi-annual financial reporting periods would be exposed to additional expense associated with more frequent financial statement updating and an accelerated timetable for annual audits, or be barred from raising capital in the U.S. public markets. Even issuers in jurisdictions with financial statement periods identical to those under proposed Item 8 could be exposed to costly delays, since U.S. GAAP reconciliation can take significant time to complete after the issuer=s financial statements are completed in accordance with local GAAP.
Finally, such a proposal may be viewed as unfair by foreign private issuers that subjected themselves to the Exchange Act reporting regime in reliance upon the standard of Rule 3-19. By proposing to change Rule 3-19, the Commission threatens to withdraw an accommodation introduced only a short time ago, without any showing of abuse or other detriment to U.S. investors. Reversing position in so short a time will not only feed foreign private issuers' concerns about the burdens associated with U.S. registration, but also exacerbate their fear that in choosing to come under the jurisdiction of the Commission, they are vulnerable not only to new regulatory requirements, but also to unexpected reversals of Commission policy. In light of the significant differences in U.S. and foreign reporting requirements, and the significant cost of reconciliation, we believe it is appropriate for the Commission to grant non-U.S. companies sufficient time to prepare their audited reconciled annual financial statements.
We urge, therefore, that the Commission leave unchanged Rule 3-19 of Regulation S-X, which we believe adequately balances investors' need for recent financial statements with the need to recognize the cost of reconciliation and the differing reporting requirements of most offshore jurisdictions. If financial statements are timely for Exchange Act purposes in the trading markets, they ought to be considered timely for purposes of registration as well. We recognize that the Commission has proposed to shorten the filing period for annual reports on Form 20-F. See SEC Release No. 7606A (Nov. 13, 1998). The ability of existing registrants to meet such requirement as well as the potential for discouraging new registrants needs to be carefully considered before the Commission adopts any acceleration of Form 20-F filing requirements.
More Extensive Management Disclosure
Certain of the new disclosure requirements for directors and officers of a registrant in proposed Item 6, especially the requirement to disclose the details of severance agreements, exceed those of many foreign jurisdictions. In developing the special disclosure requirements applicable to foreign private issuers, the Commission has repeatedly recognized that certain information about directors and officers required to be disclosed by Commission requirements applicable to domestic issuers, but not by the comparable disclosure requirements of certain foreign jurisdictions, might justifiably be deemed nonpublic information in the context of local business cultures outside the United States. The Commission has decided that, on balance, the materiality of that information to investors was not so great as to justify deterring foreign issuers' access to the U.S. capital markets on that basis alone. See, e.g., SEC Release No. 34-18279 (Nov. 20, 1981); SEC Release No. 34-16371 (Nov. 29, 1979); and SEC Release No. 34-7748. Nothing has occurred to change the result of that analysis today. Therefore, until other jurisdictions adopt the stricter disclosure requirements of proposed Item 6 for domestic purposes, we suggest that the Commission allow local jurisdictions to strike their own balance between privacy and the disclosure of such information.
Five Percent Beneficial Ownership Threshold
If the Commission determines to decrease the threshold for disclosing beneficial ownership to five percent or more of the registrant's voting securities, the Commission should make explicit, as is currently proposed, that the requirement is qualified by what the company knows or can ascertain from public filings.
Definition of "Beneficial Ownership"
The inclusion of a definition of "beneficial ownership" in General Instruction F to Form 20-F is helpful. However, we suggest that the Commission use the same definition for disclosure of beneficial ownership as is used for domestic U.S. companies, namely that currently found in '240.13d-3. The definition proposed in the release includes anyone who has the power "to receive the economic benefit of ownership." The definition in Instruction F, as proposed, would thus raise new interpretive issues and, as the Commission has learned from its experience interpreting Section 16 under the Exchange Act, any definition that incorporates the concept of "economic benefit" creates especially difficult interpretive problems.
Issuers should be able to rely on information regarding beneficial ownership from beneficial owners' filings under Section 13(d) rather than having to investigate whether some other persons have a discernible economic interest.
Definition of "Foreign Private Issuer" in ' 230.405 and ' 240.3b-4
The method of calculating record ownership in ' 240.12g3-2(a) is not practicable. Many foreign banks and depositaries, including Euroclear and Cedel, are prohibited from releasing the identities of their account holders. Even in the United States, many account holders object to the release of their identities. With regard to a substantial percentage of their securities, therefore, issuers are generally unable to obtain the information regarding account holders required by Rule 12g3-2(a). While we recognize that some U.S. investors may hold shares in overseas accounts, an investor's decision to do so is generally not within the issuer's control. We believe it is highly unlikely that any such offshore accounts by U.S. investors will be used to manipulate an issuer's status as a "foreign private issuer." Accordingly, we urge the Commission not to adopt Instruction A. More useful would be a presumption that securities held in accounts in overseas banks and depositaries (including Euroclear and Cedel) are beneficially owned by non-U.S. residents unless the issuer receives information indicating otherwise.
The presumption that all ADR holders are U.S. residents is wrong. In fact, for many foreign companies, the U.S. ADR market has become the single most important market for their shares outside their home country. Many foreign investors, particulary Latin American investors, hold ADRs for their shares. Requesting a list of beneficial owners through the depositary is costly ($.15 - $.20 per name, according to one source) and unreliable, since many account holders are either untraceable or object to the release of their identities. Most foreign private issuers, therefore, do not request such lists. Accordingly, we urge the Commission not to adopt Instruction B.
If the Commission or the staff have any questions concerning the foregoing, please call
Linda C. Quinn at (212) 848-8747, Arbie Thalacker at (212) 848-7085 or Ottilie L. Jarmel at (212)
Very truly yours,
Shearman & Sterling
cc: Brian Lane
Sandra Folsom Kinsey