United States Securities Regulation and Foreign Private Issuers: Lessons from the Sarbanes-Oxley Act

Is the United States losing its position as the world's leading capital market? Recent statistics suggest that U.S. stock exchanges have been losing ground to foreign stock exchanges. The share of equity raised in global public markets represented by the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX) combined dropped from 28.8% in 2002 to 23.0% in 2009.1 1Comm. on Capital Markets Regulation, The Competitive Position of the U.S. Public Equity Market 7 (Dec. 4, 2007), available athttp://www.capmktsreg.org/pdfs/The_Competitive_Position_of_the_US_Public_Equity_Market.pdf; World Fed'n of Exch., 2009 Annual Report and Statistics 118, available athttp://www.world-exchanges.org/files/statistics/excel/WFE09%20final.pdf. Foreign delistings from the NYSE rose from 3.9% of all listed foreign companies in 1997 to 8.7% in 2009.2 2Comm. on Capital Markets Regulation, supra note 1, at 21; World Fed'n of Exch., supra note 1, at 104–05. The U.S. market capitalization decreased from 47.8% of the total global market capitalization in 1999 to 31.6% in 2009.3 3 Brown, Elizabeth F., The Tyranny of the Multitude Is a Multiplied Tyranny: Is the United States Financial Regulatory Structure Undermining U.S. Competitiveness?, 2 Brook. J. Corp. Fin. & Com. L. 369, 393– 94 (2008); World Fed'n of Exch., supra note 1, at 102. Market capitalization is as measured by the World Federation of Exchanges. Although in 2000, nine of the top ten initial public offerings (IPOs) in the world took place on U.S. exchanges, by 2005, only one of the twenty-five largest IPOs took place on a U.S. exchange.4 4Eric Pan, Why the World No Longer Puts Its Stock in Us 2–3 (Dec. 13, 2006) (Benjamin N. Cardozo Sch. of Law Jacob Burns Inst. for Advanced Legal Stud. Working Paper No. 176), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=951705. In the first half of 2010, Asian exchanges dominated equity IPOs, with $22.6 billion raised on the Shenzhen Stock Exchange and US$8.9 billion raised on the Shanghai Stock Exchange as opposed to $6.7 billion on the NYSE.5 5World Fed'n of Exch., Market Highlights For First Half-Year 2010, 8, available athttp://www.world-exchanges.org/files/file/stats%20and%20charts/July%202010%20WFE%20Market%Highlights.pdf. Commentators argue that one reason for the declining importance of the U.S. stock markets is the high level of regulation in the United States, especially after the passage of the Sarbanes-Oxley Act in 2002.6 6Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat 745 (codified in scattered sections of 11, 15, 18, 28, and 29 U.S.C.) [hereinafter SOX]. Proponents of regulatory competition argue that the U.S. securities regulatory regime is too onerous and that companies should, instead, be allowed to choose which jurisdiction's securities law should apply to them. See, e.g., Choi, Stephen, Regulating Investors Not Issuers: A Market-Based Proposal, 88 Cal. L. Rev. 279 (2000); Choi, Stephen J. & Guzman, Andrew T., Portable Reciprocity: Rethinking the International Reach of Securities Regulation, 71 S. Cal. L. Rev. 903 (1998); Coffee, John C., Racing Towards the Top?: The Impact of Cross-Listings and Stock Market Competition on International Corporate Governance, 102 Colum. L. Rev. 1757 (2002); Palmiter, Alan R., Toward Disclosure Choice in Securities Offerings, 1999 Colum. Bus. L. Rev. 1; Romano, Roberta, Empowering Investors: A Market Approach to Securities Regulation, 107 Yale L.J. 2359 (1998). But there is also a concern that regulatory competition will lead to a race to the bottom. See Cox, James D., Choice of Law Rules for International Securities Transactions?, 66 U. Cin. L. Rev. 1179, 1186 (1998) (arguing the parties should not be able to avoid U.S. securities regulation in private securities transactions partly because there is a "need to protect investors from themselves"). For more on the regulatory competition debate, see Jackson, Howell E. & Pan, Eric J., Regulatory Competition in International Securities Markets: Evidence from Europe in 1999—Part I, 56 Bus. Law. 653, 658 (2001). In response to comment letters from many foreign private issuers requesting exemptions from some of the requirements of SOX, the Securities and Exchange Commission (SEC) did grant certain accommodations. In addition, in 2007, the SEC adopted a rule that allowed certain foreign private issuers to deregister and no longer be subject to U.S. securities regulation (the "deregistration rule"). With the recent global financial crisis, however, there have been renewed calls for more stringent U.S. regulation to prevent future financial crises.7 7 See, e.g., Coffee, John C. & Sale, Hillary A., Redesigning the SEC: Does the Treasury Have a Better Idea?, 95 Va. L. Rev. 707 (2009); Cunningham, Lawrence A. & Zaring, David, The Three or Four Approaches to Financial Regulation: A Cautionary Analysis Against Exuberance in Crisis Response, 78 Geo. Wash. L. Rev. 39 (2009). The current crisis has rattled world markets, resulting in, among other events, the bankruptcy of Lehman Brothers and some foreign governments needing International Monetary Fund packages.8 8 See, e.g., Davidoff, Steven M. & Zaring, David, Regulation by Deal: The Government's Response to the Financial Crisis, 61 Admin. L. Rev. 463 (2009); Okamoto, Karl S., After the Bailout: Regulating Systemic Moral Hazard, 57 UCLA L. Rev. 183 (2009). In a November 17, 2009 speech, SEC Commissioner Kathleen Casey stated that one of the lessons of the current financial crisis is that financial stability depends on investor confidence, which in turn depends on the transparency of financial statements.9 9Kathleen L. Casey, Comm'r, SEC, Lessons from the Financial Crisis for Financial Reporting, Standard Setting and Rule Making (Nov. 17, 2009), available athttp://www.sec.gov/news/speech/2009/spch111709klc.htm. As Congress had directed the SEC to review and study fair value accounting standards, the SEC delivered a report that included several recommendations on changes to fair value accounting standards to Congress which may result in new securities regulations.10 10 Id. In an increasingly global market, it is important for the United States to understand—before undertaking further reforms—the effects of increased securities regulation on the competitiveness of its stock markets. While U.S. securities laws should be reformed to decrease the risk of, and mitigate the effects of, future financial crises, absent a global harmonized regulatory regime, the United States should be careful to minimize the costs imposed by U.S. securities regulation on foreign private issuers.11 11"Foreign private issuer" is defined in Rule 405 promulgated under the Securities Act of 1933 and Rule 3b-4 promulgated under the Securities Exchange Act of 1934. 17 C.F.R. §§ 230.405, 240.3b-4 (2010). The United States benefits from foreign private issuers listing on domestic exchanges. And, U.S. investors find it easier to invest in shares of foreign companies if they are listed in the United States. In addition, foreign private issuers listed in the United States are subject to U.S. securities law, which provides better investor protection than many comparable foreign laws.12 12 See infra Part I.A. The experience of foreign private issuers accessing the U.S. market in the 2000s, especially after SOX and the deregistration rule, provides useful guidance regarding the effect of strengthened U.S. securities law on the attractiveness of U.S. markets for foreign private issuers. In this article, I examine the impact of post-SOX strengthening of U.S. securities law on the conduct of foreign private issuers. Part I provides some general background about foreign private issuers listing in the United States. It starts by discussing the benefits to the United States of having foreign private issuers list on U.S. exchanges. Part I also explores the costs and benefits of listing in the United States for foreign private issuers, especially in light of potential flowback13 13"Flowback" refers to American investors choosing to convert their American Depository Receipts (ADRs) into ordinary shares that are traded on non-U.S. stock markets. problems and the increasing availability of foreign exchanges as alternatives to the U.S. exchanges. Next, in Part II, I discuss the legal regime facing foreign private issuers, looking at the SEC's pre-SOX attempts to make the U.S. markets more attractive to them, at the controversy over the application of SOX to foreign private issuers, and at the SEC's post-SOX accommodations for foreign private issuers. Part II also reviews prior studies on SOX's effects on foreign private issuers. Part III then describes my three studies of foreign private issuers' behavior after SOX. The first study looks to see if, in a given region, the median relative U.S. trading volume14 14"Relative U.S. trading volume" refers to the trading volume the issuer obtains in the United States over the trading volume the issuer obtains in its home market. "Trading volume" is the number of shares of a security traded in a given market during a given day. For details on the calculation for relative U.S. trading volume, see infra Part III.A.1. of issuers that delist tends to be lower than the median relative U.S. trading volume of issuers that do not and to see which region's issuers are likely to find the United States to be a less important market. For each of the six regions15 15The six regions are East Asia, Europe, Latin America, Japan, Israel, and Australia. See infra Part III.A.1. I studied, issuers who remain listed on the U.S. exchanges as of January 31, 2010 tend to have lower relative U.S. trading volumes than those who voluntarily delisted16 16Issuers who voluntarily delisted are those who exited the U.S. market other than (i) those who were delisted by a U.S. exchange or (ii) those who were merged into another company. before January 31, 2010. Issuers from developed countries tend to have lower relative U.S. trading volumes. My second study finds that more issuers from regions with lower relative U.S. trading volume voluntarily delisted from the United States after the passage of SOX. My third study reviews SEC filings, cataloging the reasons foreign private issuers give for delisting. Many of the delisting issuers stated in press releases filed with the SEC that their low trading volumes in the United States did not justify the costs of being listed in the United States, especially after the additional regulatory burden imposed by SOX. Finally, I conclude by looking at the implications of the finding that issuers from developed regions with low relative U.S. trading volumes are more likely to delist as a result of increased securities regulation imposed by SOX. Because issuers from more developed countries are better investment prospects for U.S. investors, the SEC should consider granting these foreign issuers exemptions from any new U.S. securities regulations, to encourage them to continue listing in the United States. This part provides some general background, discussing the reasons the United States wants to encourage foreign private issuers to list on its exchanges. To maintain these benefits, the United States must ensure that a U.S. listing provides foreign private issuers with more benefits than costs, especially as foreign private issuers may face flowback problems, and foreign securities exchanges are increasingly becoming viable alternatives to U.S. exchanges. This part discusses the benefits and costs for foreign private issuers listing in the United States. Understanding both the benefits to the United States of having foreign issuers list on U.S. exchanges and what foreign private issuers perceive to be the benefits and costs of listing in the United States then assists in a determination of which foreign private issuers should be encouraged to list in the United States and how the U.S. securities regulations might be used to encourage these issuers to list. U.S. retail investors and the overall U.S. capital markets benefit from foreign private issuers listing in the United States. Investing in foreign companies provides investors with diversification, allowing them to select the optimal trade-off between risk and return.17 17U.S. Chamber of Commerce Comm'n on the Regulation of U.S. Capital Markets in the 21st Century, Report and Recommendations 39 (Mar. 2007), available athttp://library.uschamber.com/sites/default/files/reports/0703capmarkets_full.pdf [hereinafter U.S. Chamber of Commerce Comm'n Report]; Jackson, Howell E., A System of Selective Substitute Compliance, 48 Harv. Int'l L.J. 105, 111 (2007); Tafara, Ethiopis & Peterson, Robert J., A Blueprint for Cross-Border Access to U.S. Investors: A New International Framework, 48 Harv. Int'l L.J. 31, 41 (2007). Further, foreign companies are attractive to U.S. retail investors because many of the fastest-growing companies are foreign companies.18 18U.S. Chamber of Commerce Comm'n Report, supra note 17, at 39; Davidoff, Steven M., Regulating Listings in a Global Market, 86 N.C. L. Rev. 89, 115– 16 (2007); Jackson, supra note 17, at 111; Tafara & Peterson, supra note 17, at 48. U.S. retail investors can invest abroad but they face certain barriers. First, there are risks associated with investing in a foreign market.19 19Jackson, supra note 17, at 112; Tafara & Peterson, supra note 17, at 41–42. U.S. retail investors investing abroad may be unaware that they are investing in securities not subject to SEC oversight.20 20Jackson, supra note 17, at 112; Tafara & Peterson, supra note 17, at 42. Foreign countries may not have an effective legal enforcement regime.21 21Tafara & Peterson, supra note 17, at 42. It is easier and less risky for U.S. retail investors to invest in foreign companies if they are listed in the United States.22 22U.S. Chamber of Commerce Comm'n Report, supra note 17, at 39; Tafara & Peterson, supra note 17, at 41. Listing in the United States subjects the foreign private issuer to U.S. securities law, which gives better investor protection than comparable law in many foreign jurisdictions.23 23Tafara & Peterson, supra note 17, at 42; Doidge, Craig G. et al., Why Are Foreign Firms Listed in the U.S. Worth More?, 71 J. Fin. Econ. 205, 209 (2004). Second, there are transactional costs associated with investing abroad. To invest abroad, U.S. investors often either have to trade on a foreign exchange through a U.S.-registered broker, thereby having to go through two layers of intermediaries, or have to open an account with a foreign broker.24 24Jackson, supra note 17, at 111; Tafara & Peterson, supra note 17, at 47–48. U.S. retail investors may also lack adequate information about these foreign companies because foreign private issuers and foreign financial broker-dealers that do not comply with SEC registration and compliance requirements are not able to directly solicit U.S. retail investors.25 25U.S. Chamber of Commerce Comm'n Report, supra note 17, at 39; Jackson, supra note 17, at 111; Tafara & Peterson, supra note 17, at 48. Maintaining an environment friendly to foreign private issuers is important to the United States remaining the global financial center. Foreign private issuers constitute a significant portion of the IPOs and listings in the United States.26 26Brown, supra note 3, at 395. U.S. exchanges benefit from being able to obtain listing and trading fees, one of their major sources of revenue, from foreign private issuers that list on them.27 27Davidoff, supra note 18, at 127–28. For the schedule of fees paid to NYSE, see http://www.nyse.com/regulation/nyse/1147474807417.html (last visited Oct. 15, 2010). Regarding NASDAQ's fees, see NASDAQ, Listing Standards and Fees ( July 2010), available athttp://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf. Keeping the U.S. markets attractive to foreign private issuers is important for maintaining the dominance of U.S. financial services sector, an important sector for the United States. One out of every nineteen Americans works in financial services and the industry represents eight percent of the U.S. gross domestic product.28 28Michael R. Bloomberg & Charles E. Schumer, Sustaining New York's and the US' Global Financial Services Leadership 10 ( Jan. 2007), available athttp://www.nyc.gov/html/om/pdf/ny_report_final.pdf. The financial services industry is also one of the fastest-growing sectors in the U.S. economy.29 29 Id. Continued growth in this industry provides the United States with jobs and tax revenues.30 30 Id. at 9–10. To obtain such benefits, the United States needs to make sure that the benefits of listing in the United States for desirable foreign companies outweigh the costs. Foreign private issuers typically list in the United States for financial considerations such as increased liquidity, potentially lower cost of equity capital, a desire to increase their U.S. shareholder base, and ability to raise money from equity.31 31 See G. Andrew Karolyi, What Happens to Stocks That List Shares Abroad? A Survey of the Evidence and Its Managerial Implications 34–35 (Sept. 1996) (NYSE Working Paper No. 96-04), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1612; Bancel, Franck & Mittoo, Usha R., European Managerial Perceptions of the Net Benefits of Foreign Stock Listings, 7 Eur. Fin. Mgmt. 213, 224– 25 (2001) (surveying European managers); Fanto, James A. & Karmel, Roberta S., A Report on the Attitudes of Foreign Companies Regarding a U.S. Listing, 3 Stan. J.L. Bus. & Fin. 51, 63– 66 (1997); Mittoo, Usha R., Managerial Perceptions of the Net Benefits of Foreign Listing: Canadian Evidence, 4 J. Int'l Fin. Mgmt & Acct. 40, 58 (1992) (surveying managers of Canadian companies cross-listed in the United States and the United Kingdom); Pagano, Marco et al., The Geography of Equity Listing: Why Do Companies List Abroad?, 57 J. Fin. 2651, 2685– 87 (2002) (looking at companies listed on ten major European exchanges and seeing who listed in the United States rather than in Europe). Listing in the United States also provides foreign private issuers with acquisition currency, prestige, and publicity.32 32 See Bancel & Mittoo, supra note 31, at 224–25; Fanto & Karmel, supra note 31, at 63–66. Some foreign private issuers list because all the companies in the relevant industry list in the United States.33 33 See Fanto & Karmel, supra note 31, at 52, 63–66. Another potential reason to list in the United States is that U.S. investors may be better able to identify which of the new, innovative firms are likely to succeed.34 34 See Asher Blass & Yishay Yafeh, Vagabond Shoes Longing to Stray: Why Foreign Firms List in the United States 16 (unpublished manuscript, on file with author), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=248948. Previous studies have found that foreign private issuers' perceptions of the benefits of listing in the United States have a basis in reality. Studies have found that cross-listing in the United States leads to increased liquidity,35 35 See Foerster, Stephen R. & Karolyi, G. Andrew, International Listings of Stocks: The Case of Canada and the US, 24 J. Int'l Bus. Stud. 763, 773– 79 (1993) (looking at fifty-three Toronto Stock that listed on U.S. exchanges from to Karolyi, supra note 31, at decreased to domestic market See Foerster, Stephen R. & Karolyi, G. Andrew, The of Market and on Evidence from Foreign Stock Listing in the United States, J. Fin. (looking at firms from countries that listed in the United States between and Karolyi, supra note 31, at But see et al., of to Markets and Its on J. Int'l from between and that total risk decreased for firms but not for firms after the of the and increased See et al., International Cross-Listings and J. Fin. & Analysis (2002) from a study of a one before and one after a listed in the NYSE or Stock Exchange and from the number of a is in the and the Financial during the in that and increase after listing on the for foreign private issuers. to the cost of capital and increase share for foreign private issuers, both the and the of these effects are See & The Impact of an NYSE Listing on the Global of Stocks 2–3 (NYSE Working Paper No. foreign listed on the NYSE between and and that from developed markets on increase in home market value of trading after from markets experience only a increase in home market et al., The Market Impact of The Case of 2 (1998) (looking at eight listed in the United States or traded on markets between and and finding no of listing R. & Market and the of Capital in International Equity 35 J. Fin. & Analysis from foreign that their first between and that cross-listing the cost of capital for foreign & Karolyi, supra note at that foreign a significant during the before listing and also during the listing but that shares on during the after Karolyi, supra note 31, at 35 that share increased in the first after listing but that during the after listing The Market to International Evidence from J. Fin. Econ. from foreign that their first between and that the of a listing were for firms that list on major U.S. & E., of Foreign Listings on U.S. J. Int'l Bus. Stud. effect from equity of foreign firms listed on the NYSE and the between and But see & J., Are to Rev. Fin. Stud. there an increase in there a for to several after listing and there of a effect on for firms While private for foreign private issuers tend to their home market on major U.S. public exchanges tend to the relevant et al., supra note at Foerster, Stephen R. & Karolyi, G. Andrew, The of Global Equity Offerings, 35 J. Fin. & Analysis Foreign private issuers obtain more of a if they from markets with lower accounting standards or lower of investor et al., supra note at & Karolyi, supra note at The increased may be because investors see a to list on an exchange with a environment as a of about its future 41 See C. & Disclosure and Listing on Foreign Stock J. & Fin. Listing in the United States may also increase the value of the shares because it the ability of a shareholder to private benefits from the See Doidge, Craig U.S. Cross-Listings and the Benefits of Evidence from J. Fin. Econ. that foreign firms that list in the United States and are subject to U.S. securities regulation tend to have lower than firms that do especially if these foreign firms are from countries with shareholder et al., supra note See also & Benefits of International J. Fin. (2004). and because it in non-U.S. firms and increased et al., and Does Listing in the United States a and Market 41 J. Acct. Foreign private issuers that list in the United States tend to their equity to and to into than do foreign companies not listed in the United Evidence from of U.S. The of Stock as an (Sept. (unpublished manuscript, on file with author), available & Cross-Listings and Evidence, 34 Fin. Mgmt. Firms from regions list in the United States for For European issuers, the reason to list in the United States is better by and the desire to obtain acquisition See Jackson, Howell E. & Pan, Eric J., Regulatory Competition in International Securities Markets: Evidence from Europe in 1999—Part II, 3 Va. L. & Bus. Rev. 224– 25 (2008); see also et al., supra note 31, at that of listing in the United States are the of and investors, than in Europe, and a The reasons firms list in the United States on their firms list to they can comply with the U.S. securities law requirements and to and is a less important because the market is M. Regulation of Issuers U.S. Public Equity Markets (2002) (unpublished manuscript, on file with on the other list to of increased and relative See at For issuers from other Asian the reason to U.S. markets is better from the liquidity, by 48 See Regulatory Competition in International Securities Markets: Evidence from in and (2002) (unpublished manuscript, on file with Regulatory Competition in International Capital Markets: Evidence from in 3 J.L. & Bus. 61 Asian issuers have found that they to go to the U.S. market for transactions over See at 13, Some Asian and firms list in the United States because they their home listing supra note at In addition, the has encouraged some to list in the United States to to the of their for to comply with U.S. securities listed must effective Id. at 21; supra note at Finally, listing in the United States firms to convert their to U.S. allowing them to obtain acquisition supra note at firms list in the United States to be subject to lower if they are listed on a U.S.

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