SEC Proposes to Allow Foreign Issuers to Deregister based on a 5% U.S. Trading Volume Test

At its open meeting on December 13, 2006, the Securities and Exchange Commission proposed a new version of a rule that would allow a foreign private issuer to terminate its SEC registration when its United States share trading volume is 5% or less of its home country trading volume. This test is similar to a proposal made by a group of European organizations, with the support of Cleary Gottlieb, in February 2004.

The new proposal represents a significant liberalization compared to the SEC’s first proposal, which was made in December 2005. Under that proposal, deregistration would have been possible only if a foreign issuer’s U.S. shareholder base was less than a percentage of the issuer’s worldwide public float (5% for small issuers and 10% for large issuers, which were also subject to a trading volume test).

While the text of the rule is not yet available, it is likely that the new proposal will receive considerable support from foreign companies worldwide, and particularly from the European companies that proposed a 5% trading volume test in 2004. The trading volume test should be simpler for most companies to apply than the public float test, and a significantly larger number of companies should be eligible for deregistration.

The SEC said that the new rule is intended to improve the competitive position of U.S. capital markets. Coupled with flexible new guidance on the application of Section 404 of Sarbanes-Oxley (which requires costly reports on internal controls), and with progress towards accepting IFRS financial statements without U.S. GAAP reconciliation (currently targeted for 2009), the deregistration rule should make the U.S. market significantly more hospitable for non-U.S. companies.

The SEC said at the open meeting that a company would measure its trading volume over a 12-month period. If the company terminates a U.S. listing or an ADR program, it must wait for a year before deregistering. The SEC said the purpose of the waiting period is to dissuade companies from terminating listings or ADR programs solely to meet the deregistration threshold.

In addition to changing the threshold, the SEC has made a number of other important changes to the December 2005 proposal:

• The SEC has limited the “one-year dormancy period” to registered securities offerings. A company cannot deregister for a year after a registered offering. The December 2005 proposal would have applied the “one-year dormancy period” to private offerings, meaning that many foreign companies would have excluded U.S. institutions from their capital raising activities.
  
  
• Companies that have deregistered under the prior regime are eligible to make their deregistration permanent. Under the December 2005 proposal, deregistration would have been permanent only for companies using the new rule, while companies that had deregistered under the old rules would have been required to have less than 300 U.S. shareholders at the end of each year (potentially forever) in order to remain deregistered.
  
  
• A company that becomes a registrant as a result of a business combination transaction as a “successor” to a U.S. listed target will be able to deregister shortly after the business combination transaction (the SEC staff did not specify how quickly the successor will become eligible for deregistration). Under current rules, if a French company uses shares to acquire a U.S.-listed German company, the French company becomes automatically (and possibly permanently) registered with the SEC, even if the acquisition transaction itself is exempt from U.S. tender offer and securities offering rules.
  
  
• The new proposal does not distinguish between small companies and large companies. The December 2005 proposal would have made it easier for large companies to deregister, even though U.S. compliance costs are often disproportionately higher for small companies.
  

In addition to liberalizing the deregistration rule, the SEC has proposed to modify Rule 12g3-2(b), a rule that allows companies to avoid initial registration if they send English versions or summaries of their home country documents to the SEC. Many companies with “Level 1” ADR programs use this rule. Those companies will be allowed to post the documents on their websites, rather than sending paper copies to the SEC, reducing their administrative burden. The December 2005 proposal would have allowed website publication only for companies using the new deregistration rule.

While the proposed new rule appears to be favorable overall to foreign issuers, there will undoubtedly be technical issues to be raised during the comment period. For example, the 5% test will be calculated by dividing U.S. trading volume by primary market trading volume, rather than worldwide trading volume. Using worldwide trading volume would increase the number of companies that are eligible for the new rule.

The comment period will be 30 days from publication, so comments will probably be due in late January. The SEC stated that it intends to move quickly, hoping to adopt the final rule by the end of the first quarter, allowing eligible companies to deregister before the June 30 deadline for filing a Form 20-F.

The SEC’s press release describing the proposal can be viewed at the following link:

http://www.sec.gov/news/press/2006/2006-207.htm.

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