Escaping the glare

The comments period over the SEC’s proposals to relax its deregistration rules for foreign companies has recently closed. With more and more companies turning their backs on the US markets, Tom Allchorne looks at what the SEC wants to do, and how Europeans have greeted this.

The stringent reporting requirements of the Sarbanes-Oxley Act has resulted in a large number of non-US companies delisting from the US public markets and deregistering from the Securities and Exchange Commission (SEC). The current reporting requirements are both time-consuming and expensive argue critics, in particular singling out Section 404, which requires certification of internal controls by both the issuer and its auditors. ITV withdrew from the US last year, claiming the move will save it £4m in 2005 and £3m annually thereafter, largely due to the cost of adhering to Section 404.

Unfortunately deregistering is a rather difficult thing to do thanks to a piece of legislation that dates back to 1934, the US Securities Exchange Act. Under existing rules, a company cannot deregister if it has more than 300 US shareholders, or 500 for certain smaller businesses. Calculating the number of shareholders residing in the US is also a major obstacle. It is a lengthy process whereby an issuer has to “look through” brokers, dealers, banks and other nominees across the world in order to find out where its shareholders reside. If it is found a company has more than 300 US shareholders, the steps it can take to reduce this number can be both time-consuming and costly, not to mention potentially giving rise to legal challenges from aggrieved shareholders.

The SEC has not been immune to the cries from the European business community appealing for it to relax deregistration rules, and also takes the view that by relaxing deregistration rules it will encourage future listings as companies will be able to enter the market knowing they could exit it easily if they so wish. The Commission realises that increasing globalisation of the securities market has meant the 300 shareholders limit is out of date.

In December it announced proposals to make the process easier, and if a company passes any one of the following three tests, it will be eligible for deregistration: if US investors hold no more than 5% of its shares; if US investors hold 10% or less of its shares and account for no more than 5% of its daily trading volume (this is aimed at the larger companies); and if the company has fewer than 300 US shareholders (this is just a fall-back test to ensure the rules are equally fair as the existing ones).

The rule governing the calculating of US shareholders is also to be relaxed. Under new proposals, this would just be limited to brokers, dealers etc in the US, the issuer’s jurisdiction of incorporation, and the issuer’s primary trading market, if different. The comment period closed on February 28.


For the European business community the proposals do not go far enough. On March 1 (a day late, but what the hey), the European Commission submitted its comments. It welcomed the SEC’s attempts to make it easier for non-US companies to deregister, but said: “only a fraction of European companies currently registered with the SEC would be able to terminate their registration under the proposed rule changes.”

Because US investors hold a substantial amount of European shares, many European companies would still need to be registered with the Commission. According to the EC letter, of the 70 European issuers with the largest market capitalisation on the US public markets, only two from France, two from the UK, one or two from Italy, one from the Netherlands and probably none from Germany would be eligible to benefit from the new rules.

The EC also points out that institutional investors make up the overwhelming majority of US shareholders in European companies: on average 20% of the equity in large European businesses rests in the hands of US institutions. It’s argued such investors do not need the same level of protection as retail investors, for whose benefit Sarbanes-Oxley was really drawn up. “Large institutional investors have the necessary expertise and resources to make effective use of the information provided by foreign issuers in the disclosures and financial reporting required under the law of their home jurisdiction,” the letter says.

The EC recommends the SEC exclude some US institutional investors from the calculation process, eg on the basis of the ten largest shareholders or those with a minimum investment of US$10m. Failing this, the threshold of deregistration of 5% and 10% should be raised to 25%. The EC also suggests, in addition, that the limit of 300 US shareholders be changed to 3,000 due to the significant increase in the growth of foreign equity in the US. In 1967, which is when the 300 rule was implemented, US residents owned US$5.2bn of foreign equity. The level now stands at US$2,821.1bn.

Under certain circumstances, companies can issue shares and still escape the SEC’s glare. Large US shareholders are generally “qualified institutional buyers” (QIBs) and in certain circumstances the SEC has decided they do not need the protection of reporting requirements (under Rule 144A it is possible for foreign issuers to offer shares to QIBs without having to register with the Commission). A number of respondents to the SEC’s request for suggestions have argued this should be extended to all QIBs in non-US companies, not least of all a combined submission by a whole host of European organisations like EALIC (European Association for Listed Companies), and the CBI.

Next steps

There is an increasing sentiment that listing in the US simply isn’t worth it. Sarbanes-Oxley has had a significant impact in that regard, but also the lack of liquidity in the US capital markets has made companies think twice about going public in New York when it’s easier to do it in London and when US institutional investors are more than willing to follow them there. Europe having more IPOs than the US is nothing unusual, it’s been that way since PricewaterhouseCoopers started its IPO Watch survey in 2001, but 2005 was the first time Europe has outperformed in terms of value. There were 603 European IPOs last year, raising a little over €50bn, whereas the US public markets saw 205 IPOs raise €27bn.

Europe has over 7,000 public companies, and just 300 of these are registered with the SEC despite US investors owning shares in many of them. PricewaterhouseCoopers reckons there were 129 international IPOs in the European markets during 2005, including 13 US companies, raising €9.6bn. In the US there were 23, raising €3bn.

Ned Martin, a partner at DLA and a 35-year veteran of the industry, believes the SEC is listening to the complaints: “The Commission is concerned about accessibility to the market for Americans. The SEC doesn’t like to see delistings from US exchanges because it means the accessibility of US citizens to the public markets is reduced.”

For his part, Martin thinks the change of the role of analysts has had a bigger impact on the US exchanges. Referring to the Spitzer reforms, named after New York Attorney General Eliot Spitzer, analysts are no longer allowed to talk to the investment banks nor companies preparing to float, in contrast to their former role where they were very much part of the process of introducing companies to investors. This has made NASDAQ a much more unattractive place to float for smaller companies, and so has dissuaded VCs from choosing that as a exit route.

He also argues the make-up of investors has had an impact on IPOs. “Consolidation of investors and asset managers has also made it hard to find people to invest in smaller companies. They want more liquidity and so are attracted to companies with a higher market capitalisation.” As a result, the last 12 to 18 months have seen less and less smaller businesses coming to market and more large floats.

All of these combined factors, Sarbanes-Oxley, the Spitzer reforms and investor consolidation, have made the US public markets a less attractive place to float for US VCs, let alone European venture capitalists, most of whom turn to London’s AIM market. Those determined to tap into the US market could exploit Rule144A, which is increasingly happening, although this obviously limits the number of investors eligible to purchase stock, and there are restrictions on resale.

Martin says it could take up to a year for the SEC to publish its decision, and could even offer out new proposals for further discussion, but both are unlikely he argues; summer is a more probable time.