A free pass for foreign firms? An assessment of SEC and private enforcement against foreign issuers.

• Author: Shnitser, Natalya

NOTE CONTENTS INTRODUCTION I. THE U.S. CAPITAL MARKETS AND THE CROSSLISTING PHENOMENON A. An Overview B. The Bonding Hypothesis C. Crosslisting: Procedural and Substantive Requirements 1. How Foreign Issuers Become Subject to U.S. Securities Laws 2. Exceptions and Exemptions for Foreign Issuers 3. Substantive Requirements for Foreign Private Issuers Registered with the SEC 4. Impact of Sarbanes-Oxley II. PUBLIC ENFORCEMENT AGAINST FOREIGN ISSUERS A. Scholarship on Public Enforcement B. SEC Enforcement: Previous Empirical Findings C. SEC Enforcement Against Foreign Issuers: Theoretical Expectations III. DATA AND EMPIRICAL METHODOLOGY A. Part 1: Search for Enforcement Actions Against Companies on the SEC's Lists of International Registered and Reporting Issuers B. Part 2: In-Depth Review of SEC Enforcement for Issuer Reporting and Disclosure Violations IV. EMPIRICAL RESULTS A. General Enforcement Trends B. Issuer Reporting and Disclosure Enforcement: A Comparison of Enforcement Rates C. Delinquent Issuer Enforcement: A Comparison of Enforcement Rates D. FCPA Enforcement Trends V. PRIVATE ENFORCEMENT AGAINST FOREIGN ISSUERS A. Class Action Trends in the United States B. Class Action Trends Abroad CONCLUSION APPENDIX INTRODUCTION

In both the scholarly work of the last decade and in recent policymaker reports, (1) the competitiveness of U.S. financial markets has been evaluated in part by their ability to attract foreign companies to raise capital in the United States by listing or crosslisting on U.S. exchanges. (2) While policymakers have advocated reforms to make U.S. markets more attractive to foreign firms, scholars have sought to understand exactly what draws foreign issuers to crosslist in the United States and how such companies--and their investors--are affected by the decision to sell securities in the United States. The dominant academic explanation of crosslisting has emphasized the "bonding" effect of listing on U.S. markets. (3) Building on the law and finance literature, the proponents of the bonding hypothesis have focused on the effect of legal origins, rules, and institutions on crosslisting patterns. (4) They have posited that companies from countries with weaker legal regimes and capital markets list their shares in the United States to rent a stronger securities law and enforcement regime and "leapfrog[] local impediments." (5) By submitting to the disclosure requirements and public enforcement powers of the Securities Exchange Commission (SEC), as well as to the private enforcement powers of shareholders, foreign companies have been able to credibly subject themselves to the stricter legal and regulatory requirements available in the United States, and in return, to enjoy higher market valuations and lower costs of capital.

In much of this research, however, enforcement of the securities laws--an important premise of the argument--has been "relegated to status as a given." (6) Scholars have focused on comparing the substantive doctrinal differences between various legal and regulatory regimes, but little attention has been devoted to determining whether the securities laws analyzed by scholars are being enforced or whether the nominally powerful regulators are doing their jobs. (7) Although recent scholarship has begun to examine the role of enforcement, with the exception of recent research by Kate Litvak, (8) much of the work has focused on aggregate enforcement trends or country-to-country comparisons of general enforcement patterns. (9) Since little attention has been devoted to studying enforcement patterns for crosslisted firms, the impact of the enforcement of securities laws on the crosslisting phenomenon remains poorly understood.

It may be true that on paper, U.S. securities laws are the most stringent in the world. (10) It may also true that on the whole, "the track record of foreign enforcement authorities indicates that they are generally less aggressive than their counterparts in the United States, and that even the most vigorous ones bring fewer cases and impose significantly lower penalties." (11) But what happens when one disaggregates the pattern of securities enforcement in the United States? Is the U.S. securities regime as strict as the written rules and the aggregate statistics would suggest? Is it equally strict for everyone?

At a time when U.S. regulatory agencies are under intense scrutiny, (12) this Note seeks to answer these important questions by collecting and analyzing the data on the current U.S. regulatory policy and practice for foreign issuers. While other works have noted the relative intensity of U.S. public enforcement, (13) only one paper has considered closely the treatment of foreign issuers crosslisted on U.S. exchanges. (14) In addition, the enforcement statistics provided by the SEC have often been taken as a given, without much attention to how the SEC tracks and reports its enforcement efforts. (15) This Note uses a new, systematic approach to collect recent data on the enforcement of U.S. securities law against foreign companies crosslisted on U.S. exchanges. The data reveal a notable disparity in the levels of public (SEC) enforcement of securities laws against domestic and foreign issuers.

Meanwhile, private enforcement against foreign issuers--arguably a substitute for public enforcement under the bonding hypothesis--has been hampered by recent court decisions. Although the exact reach of class-action litigation against foreign issuers remains uncertain relative to domestic issuers, foreign issuers face minimal litigation exposure when crosslisting in the United States. Even though securities litigation is most developed in the United States and the SEC is the most active securities regulator in the world, the aggregate trends mask important disparities. By showing that foreign issuers are in large part exempt from both the public and private organs of the strict U.S. enforcement regime, this study challenges a basic premise of the bonding hypothesis.

My analysis proceeds in six parts. Part I reviews the scholarly research on the motivations for and the benefits of crosslisting in the United States, with a particular focus on the mechanics of the bonding hypothesis. It then provides an overview of the process by which foreign companies crosslist in the United States and of the laws that affect foreign issuers. Part II considers the available research on public enforcement and shows that past scholarly work has focused on aggregate trends in enforcement but has overlooked important characteristics of the U.S. securities regime. Part III turns to the available data on public enforcement of U.S. laws against foreign issuers and introduces the methodology used in this Note. Part IV presents the results of my analysis, discusses the trends in SEC enforcement, and devotes special attention to a recent increase in enforcement actions for violations of the Foreign Corrupt Practices Act. (16) Part V turns to the connection between public and private enforcement. It suggests that although private enforcement against foreign issuers may be considered a substitute for public enforcement for purposes of the bonding hypothesis, recent court decisions have generally restricted private class actions against foreign issuers, thus limiting this enforcement alternative. Finally, I present conclusions and offer avenues for further research on the subject.

1. THE U.S. CAPITAL MARKETS AND THE CROSSLISTING PHENOMENON

   1. An Overview

      In 2006, the New York Stock Exchange--the largest equities marketplace in the world with a total global market value of approximately $26 trillion (17)--included 424 non-U.S, issuers valued at over $10 trillion. (18) Likewise, the NASDAQ included 275 foreign issuers from all over the world. (19) In 2007, the NYSE had 394 foreign issuers, while the NASDAQ had 262. (20) Such numbers stand in stark contrast to the figures from 1990, when just 170 foreign companies were listed on the two exchanges combined. (21) As Table 1 shows, however, since 2001 there has been a decline in the absolute number of foreign issuers that choose to crosslist. So too the geographical makeup of foreign issuers has changed. For example, Table 2 shows a decline in European issuers and an increase in companies incorporated in the Cayman and Marshall Islands. (22) To understand these crosslisting patterns, one must consider the costs and benefits of crosslisting in the United States. The next Section begins with an overview of the benefits of crosslisting. It then reviews the regulatory requirements--the on-the-book rules--faced by foreign issuers wishing to raise capital in the United States.

   2. The Bonding Hypothesis

      Much of the research on crosslisting has been driven by two empirical observations. First, firms with U.S. crosslistings exhibit a valuation premium relative to similar firms without such crosslistings. (25) The premium is greater for firms listed on exchanges (as opposed to over-the-counter (OTC) listings and private placements) that subject firms to SEC disclosure requirements and enforcement. (26) It is also greater for firms from countries where investor protection is weaker. (27) The historical average listing premium between 1990 and 2001 for foreign firms crosslisting on major U.S. exchanges was 17.5% over noncrosslisted firms. Between 2002 and 2005, the premium was 14.3%. (28) Second, foreign firms that crosslist on U.S. exchanges incur a reduction in the cost of capital, with scholars pinning the reduction between 50 and 110 basis points. (29) Thus, firms that crosslist in the United States enjoy greater valuations and lower costs of capital than do comparable firms that do not crosslist in the United States.

      What accounts for the results described above? And why do some companies but not others choose to crosslist on U.S. markets? The proposed explanations range widely and are currently being reexamined by scholars, (30) but it is...