Two novelties approved by the Securities and Exchange Commission (SEC) promise to shake up the Level 1 ADRs market – an over-the-counter segment that dismisses the fulfillment of requirements such as balance sheets in US Gaap and compliance with the Sarbanes-Oxley Act. The first of these comes into force on October 10 and prescribes an automatic waive of registration by foreign companies who wish to offer receipts for their shares in the American over-the-counter market. The second, which is a consequence of the rule having been made more flexible, is even more innovative and will also be applied as of this month.

In addition to becoming enabled to trade level 1 ADRs without going through SEC, non-American companies will also be subject to having receipts for their shares sold in the United States without having lifted a finger for this purpose. This is an evolution in the program known as unsponsored ADR, which already exists in several parts of the world and consists in an issue of receipts organized by the depositary bank, and not by the company (see box). Currently, however, these ADRs still require the company’s involvement for registration of the offering to be requested. As of now, with automatic registration, banks will be completely free to conduct an unsponsored ADR program.

The characteristics that allow a financial institution to follow through with an offering such as this are the same that enable the company to sell Level 1 ADRs under an automatic waive of registration. The company must be listed on one of the world’s stock exchanges, have at least 55% of its share-related business volume outside the U.S., and disclose its information in English. The situation would be completely new to the Brazilian market. “We were consulted both by companies interested in using the more flexible rule and by others that were curious about the possibility of being targeted by an unsponsored program”, says Thiago Giantomassi, of Demarest & Almeida Attorneys.

Initially, most Brazilian companies listed at Bovespa meet two of the three requirements. Their shares are traded on the exchange and their business is concentrated in the local market. However, those interested in unsponsored programs may stumble on the availability of documents in English. Ray Fischer, of Linklaters, observes that Rule 12g3-2(b) does not list such documents. But these refer to the records that companies must publish in accordance with the laws of their local market, provide to the stock exchange where their shares are traded, or distribute to shareholders.

Currently, in theory, the international liquidity conditions inhibit the offering of unsponsored ADR programs. Nevertheless, Curtis Smith, of Bank of New York Mellon (BNY Mellon), is considering registering the first operations under the new rules before the end of this year. “We are talking to a few clients”, he says, revealing only that the candidates come from various segments. Smith is also optimistic regarding unsponsored programs: “There is a demand on the part of the investors”.

MORE ACCOUNTABILITY – The novelty has created doubts in the Brazilian market, especially when it comes to the companies’ accountability before the American regulator. If a company is targeted by a program promoted exclusively by a depositary bank, who is accountable for any noncompliance with Rule 12g3-2(b)? The question would apply, for instance, to an event where the issuer ceases to translate documents after the program is launched. In this case, the company would be clearly failing to comply with a SEC regulation (by waiving registration without fulfilling the requirements to do so), even though the initiative to engage American investors was not theirs.

“Both the company and the depositary bank will be legally accountable before SEC”, affirms Fischer. However, as the depositary has exclusive control over the program, in practice this means that the company must notify the bank about its intention of no longer providing the information required by Rule 12g3-2(b), and request extinction of the program, if applicable. “As the depositary bank is also legally accountable for the issue of unregistered ADRs, they will certainly comply with the company’s request”, affirms the lawyer.

The fact that they are exposed to a situation where their own decision is forfeit seems to make companies uncomfortable. The heads of Proskauer Rose’s Brazilian branch, Antonio Piccirillo and Fábio Yamada, requested clarification from SEC due to a question posed by a customer. They aimed to find out if the American regulator would allow a company, even if compliant with all requirements for an automatic waive of registration, to declare itself as a non-beneficiary of the new rule. SEC has yet to reply.

MORE TRANSPARENCY – In addition to more flexibility that allows registration to be waived, another novelty promises to increase American investors’ interest in the receipts of foreign company shares. Last August 8, SEC notified the market about the approval of a rule that requires real-time disclosure of Level 1 ADR volumes and prices in the American OTC (over the counter) market.

The regulator allowed 60 days for the Financial Industry Regulatory Authority (Finra) to disclose the date when the rule will come into force, which may not exceed 30 days. In other words, the new rule will apply by early November, at the latest. “We are correcting a deficiency in Level 1. With this, we will have more business transparency”, says Smith, of BNY Mellon.