Editor: Joe, please describe the problem with foreign listings.
McLaughlin: A large part of my practice involves working with foreign companies. If they need to raise funds in the United States, they usually start by doing exempt transactions, either commercial paper or private placements. Maybe then they will consider listing, and in the past, at least, they might think about doing public offerings in the United States either for cash or to acquire other companies. That requires becoming an SEC-reporting company, and this has been an important part of the practice of many New York lawyers over the years.
Some years ago that business started becoming less frequent, certainly after Sarbanes-Oxley, when it became clear that the statute applied to foreign companies across the board and that the SEC was going to be very reluctant in accommodating foreign companies.
I do a lot of work in Germany, and only one German company has listed in the United States since Sarbanes-Oxley was passed. That is one company in five years - not enough to base a practice on. Of course, Sarbanes-Oxley was not the only impediment. Many companies were simply afraid of the litigation threat in U.S. courts if they listed or engaged in public offerings, not only from U.S. plaintiffs but also from plaintiffs in their home countries. They also faced the SEC's requirement that they reconcile their financial statements to U.S. GAAP; a lot of companies thought of this as an expensive exercise that didn't benefit investors very much. And now we have the phenomenon of many of the larger IPO's around the world being completed without any public participation in the United States. Some of the shares are sold privately to U.S. institutional investors, but the public does not get a chance to participate. As three recent high level reports have concluded, this is not a very satisfactory state of affairs when it comes to the competitiveness of the U.S. public capital markets.
Editor: What is currently being done to address the problem?
McLaughlin: The SEC has recently taken some action to help out. First of all, one of the significant drawbacks to becoming a SEC reporting company was once you got in you could never get out. The only way to get out once you listed or made a public offering in the United States was to show that you had fewer than 300 holders in the United States, and that was pretty hard to do. This was an onerous requirement that discouraged a lot of companies from coming in when they might have done so in order to test the waters on whether liquidity would develop, whether they would want to offer their employees stock-based compensation and whether interesting stock-for-stock acquisitions might be possible. The SEC has now changed those rules about exiting the SEC-reporting system. Although its first proposal was criticized for being excessively modest, the new rules that became effective in June of this year allow foreign companies to "deregister" if they can show that in a twelve month period less than five percent of their worldwide trading was done in the United States. So that's a significant improvement. I think the SEC was hoping that a lot of foreign companies wouldn't leave once the rule became effective, but unfortunately over one hundred companies have chosen to leave - some of them household names. Nevertheless, the rule still has the benefit of letting companies know that they can get out if the original reasons for a listing or public offering don't pan out over time.
The other major improvement that has not yet occurred but has been proposed is to eliminate the requirement to reconcile your financial statements to U.S. GAAP if you are putting your financial statements together on the basis of International Financial Reporting Standards ("IFRS"). The proposal says you have to be using the English language version of those standards as adopted by the International Accounting Standards Board. Many people think the SEC should allow more flexibility in this regard. I think that the SEC is going to adopt this new rule and that it will permit more flexibility for groups of countries that have adopted a particular version of IFRS.
The final part of the solution is litigation reform and what you can do about that. The three reports made some proposals, but it's one thing to make proposals, and it's another thing to see them enacted into law or adopted as SEC rules. As we have seen in connection with the many briefs filed with the Supreme Court in the Stoneridge case, litigation reform (which of course someone else might describe as cutting back on investors' remedies) is an intensely political process in this country. I think the threat of litigation is going to be something that will keep foreign companies out of the U.S. public markets for many years.
Editor: Should the SEC introduce principles-based regulation?
McLaughlin: To tell you the truth, I don't think so. My classmate in law school, Harvey Goldschmidt, with whom I don't agree on a lot of things, addressed that point recently when he referred to Rule 10b-5, which is the basis for many securities class actions. That rule says in part, make no untrue statements, and make no omissions that make your statements misleading. What could be more principles-based that that? I think it is an occupational hazard of lawyers that are being hammered with specifics to wish that the rules were based on principles and when hammered with principles to wish that the rules were more specific. I think we are all guilty of that.
I really don't see a lot of progress in that direction from the SEC, but the answer may be different on the accounting side. That's a bit different because the Financial Accounting Standards Board has really been guilty of overkill in terms of the size of its rule book and its complexity. When I give my accounting lecture here at Sidley Austin, I ask people to identify the sources of GAAP, and it becomes an amusing exercise in identifying and tallying up both the codified and non-codified principles that enter into the preparation of SEC-filed financial statements. One of the mantras here is: "Accounting is too important to be left to the accountants." That does not mean that lawyers can or should try to be accountants. It usually means in practice that the lawyer should be looking for "red flags" in the financial statements. No lawyer can hope to keep up with the accounting literature. In fact many accountants have trouble doing it too, it is just too detailed.
If the SEC adopts its proposal to eliminate the U.S. GAAP reconciliation requirement, and if it acts upon its proposal to permit even U.S. companies to use IFRS, this might encourage a healthy competition. The SEC has asked a high-level task force to examine the financial reporting system in this country, and in the end I would hope that we would get at least a simplification of the relevant accounting rules.
Editor: Should there be a federal self-examination or self-assessment privilege?
McLaughlin: People have been asking for that for a long time. I think it comes down to who the third parties are. If the privilege were to be assertable against the SEC and the government as well as private plaintiffs, you would have a hard time getting it through; if the privilege were to be assertable only against private plaintiffs, that would be an easier sell and still represent significant progress. I don't see this moving forward until after the presidential election.
Editor: Should shareholders be permitted to adopt ADR for resolving disputes with their companies?
McLaughlin: I think that is a great idea. In fact, it's an idea whose time has come for a very odd reason. Companies have tried before to include alternative dispute resolution procedures in their publicly-offered securities, and the SEC has always objected even where the securityholders had the opportunity in effect to vote on the ADR provisions, either in a proxy statement or whether or not to buy the securities as in the case of an IPO.To date the SEC has essentially prevented ADR from being used in the context of public securities, but just recently the SEC introduced a category of companies known as well known seasoned issuers or WKSIs whose registration statements become effective automatically immediately upon filing. So theoretically at least a WKSI could include an ADR provision in a new issue of bonds, and, if it were offered as part of the WKSI's shelf, the SEC would have no way of stopping it. I'm not sure how many companies would be willing to try that, but it is an idea that should be explored.
Editor: Why should foreign companies list in the United States?
McLaughlin: Well, it's a combination of factors. For a long time, foreign companies would come to the United States for the prestige of being listed and of being able to claim that they had been able to meet the highest disclosure standards in the world. On a less idealistic level, it was the notion of a more liquid secondary market, or of being able to raise money cheaply on the U.S. public markets. Most of that has gone by the boards. The prestige of appearing on the NYSE balcony with Dick Grasso to mark the start of trading after a listing is not there anymore.
Also, many companies really don't need a listing to raise money cheaply in the United States capital markets, and for the most part companies have found that there is not much liquidity in secondary market trading in the United States. So why companies come is a purely economic matter. Some of them will say they come because they want to compensate their employees with stock-based compensation. On the other hand, they could do that anyway because of the SEC's Rule 701, which permits non-reporting companies to provide stock- based compensation to employees and other people.
The best reason to come to the United States and become a reporting company would be to be able to make stock-for-stock acquisitions on a tax free basis. And a company that was determined to make some acquisitions would certainly want to consider listing despite all the impediments I have mentioned.
Editor: Is it important to attract foreign companies back to our capital markets?
McLaughlin: The practice of securities law in New York City has always had a significant foreign component. This is part of what makes securities practice in New York so interesting and rewarding. The sooner we get foreign companies interested again in offering their securities publicly in the United States and listing their securities in the United States, the better off New York and the legal practice in New York are going to be. So this is something we really should be trying to achieve.
Published November 1, 2007.
