A Lesson in ADR and SOX

1. A Lesson in ADR and SOX Comparative Intl. Labor Relations By: S. Carpenter, A. Caccamo, and K. O’Brien

2. 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

3. 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

4. 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)

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. 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

16. 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

17. The End Questions, comments?