Sarbanes-Oxley Led to a Chilling in the U.S. Cross-Listing
Hong Zhu and Ken Small
2007 - Financial professionals are increasingly questioning
the costs of the Sarbanes-Oxley Act of 2002 (SOX). Some have
argued that SOX has had a chilling effect on the cross-listings
of international companies in U.S. markets. The New York Stock
Exchange’s The Exchange (October 2005) stated:
“Since the enactment of the Sarbanes-Oxley Act tightening
corporate reporting and governance requirements, many non-U.S.
companies have shied away from the United States capital markets.”
Additionally, foreign companies currently listed in the United
States could opt to delist voluntarily if they believe the
costs of SOX compliance outweigh the benefits of cross-listing.
At the margin, foreign companies can “retreat”
to their home markets and avoid the compliance requirements
of SOX, while their domestic counterparts’ only option
is to become private.
A review of the academic
literature points to several motives for cross-listing,
including a desire to increase the visibility of the company,
to tap into a more liquid market, to signal the company’s
strength, or to follow tougher exchange requirements. Cross-listed
foreign companies are a boon to U.S. institutional and individual
investors because they allow them to take advantage of international
diversification without having to trade in a foreign market.
Maintaining foreign companies’ presence in the U.S.
market would benefit not only the cross-listed foreign companies,
but U.S. investors as well.
current environment invites a dialogue between regulators
and accounting professionals regarding SOX’s impact
on international cross-listing in the United States. What
is needed is further discussion about how the provisions
of SOX apply to cross-listed foreign companies, and further
investigation into the possibility that SOX has had a chilling
effect on cross-listings.
vast majority of foreign companies choose to cross-list
in the United States, using the American Depositary Receipt
(ADR) program. An ADR is a negotiable instrument representing
an ownership interest in securities of a non-U.S. company.
An ADR is issued by a depositary bank in the United States
and is backed by a specific number of underlying shares
held in a custodian bank. ADRs offer the same rights and
benefits for the ADR holders as the underlying shares, and
ADRs are specifically designed to facilitate U.S. investors’
purchase, holding, and sale of securities of non-U.S. companies.
ADRs are quoted and traded in U.S. dollars, settled according
to procedures governing the U.S. market, and are considered
U.S. securities. Trading of ADRs rose to 40.1 billion shares
($877 billion) in 2004, up from 4.3 billion shares ($125
billion) in 1992. U.S. institutional investors are responsible
for the growing interest in trading ADRs.
can be issued at four levels. Level I ADRs are traded over
the counter as OTC Bulletin Board or Pink Sheet issues.
Level IV ADRs are sold in a private placement and their
trading is facilitated by PORTAL, the NASD’s quotation
system for Rule 144A securities. These two ADRs require
minimal SEC registration. Both Level II ADRs (no capital
raising) and Level III ADRs (new capital raising) trade
on a U.S. stock exchange, require subsequent annual filings
(form 20-F) with the SEC, and also need partial (Level II)
or full (Level III) reconciliation with U.S. GAAP. Exhibit
1 summarizes the regulatory and reporting requirements
for the different ADR options.
studies (including William Reese Jr. and Michael S. Weisbach,
“Protection of Minority Shareholder Interest, Cross-Listings
in the United States, and Subsequent Equity Offerings,”
Journal of Finanancial Economics, 2002) have examined
ADR issuers’ motives for listing in the United States.
and categorized them as follows:
The market segmentation/investor recognition model, where
issuers seek to enhance visibility, develop or increase
analyst coverage, broaden U.S. investor base, and avoid
The liquidity model, where issuers want to increase liquidity
by decreases in transaction costs and increases in trading
The shareholder protection/legal bonding model, where
issuers offer increased protection of minority shareholders’
interest by “bonding” themselves to U.S. security
law and U.S. GAAP.
Level II or Level III ADRs entails the above advantages
of cross-listing in the United States; they also entail
full compliance with SOX.
SOX Compliance of ADRs
applies to “issuers,” as defined in section
3 of the Securities Exchange Act of 1934 (Exchange Act),
that: 1) have securities registered under section 12 of
the Exchange Act; 2) are required to file reports under
section 15(d) of the Exchange Act; or 3) file or have filed
a registration statement that has not yet become effective
under the Securities Act of 1933 and that they have not
withdrawn. Because SOX does not distinguish between U.S.
and non-U.S. issuers, and does not exempt non-U.S issuers
from its reach, the provisions that apply to U.S. issuers
also apply to non-U.S. issuers unless they are specifically
excluded by a related provision of the Exchange Act or the
Securities Act. SOX leaves it to the SEC to determine where
and how to apply its provisions to non-U.S. issuers. Certain
provisions in the Securities Act and Exchange Act do mandate
different treatment for different levels of ADR issuers.
As shown in Exhibit
1, Level I ADRs are required to comply with criminal
and whistleblower provisions of SOX, and Level IV ADRs are
required to comply with criminal provisions of SOX. Both
Level II and Level III ADRs must comply fully with all provisions
addresses, among other things, financial reporting, CEO
and CFO certifications, internal controls, risk management,
the composition of audit committees, corporate codes of
ethics, whistleblower protection, and attorney conduct (Exhibit
mandated by Congress, the SEC intended to treat foreign
issuers in the same manner as it treats domestic issuers,
because, “After all, U.S. investors trading in the
U.S. markets are entitled to the same protections regardless
of whether the issuer is foreign or domestic” (Ethiopis
Tafara, acting director, office of international affairs,
SEC, “Speech by SEC Staff: Addressing International
Concerns under the Sarbanes-Oxley Act,” June 10, 2003).
During the implementation, however, the SEC realized that
in some instances it was impossible for some foreign issuers
to comply with both the laws of their home country and the
terms of SOX. For example, Australian corporate law requires
shareholders, as opposed to an audit committee, to select
the auditor. Over time, the SEC has had to provide non-U.S.
issuers certain accommodations to take into account foreign
laws and regulations. For example, the SEC now allows nonmanagement
employees to serve as audit committee members, lets shareholders
select or ratify the selection of auditors, and permits
foreign government representation and controlling shareholder
nonvoting representation on audit committees. Cross-listed
companies availing themselves of these accommodations must
disclose their reliance on the accommodations and their
assessment of how such reliance might materially adversely
affect the ability of their audit committee to act independently.
SEC also further extended the compliance dates for non-U.S.
issuers regarding internal control (section 404) for an
additional year, to the fiscal year ending on or after July
15, 2006. Such exemptions are expected to be rare. In terms
of keeping the U.S. stock exchanges attractive to foreign
companies and competitive with other world exchanges, most
do not believe that the SEC has gone far enough in accommodating
non-U.S. issuers under SOX. Exhibit
2 summarizes the effective dates of implementing certain
sections of SOX for Level II and Level III ADRs, and Exhibit
3 lists the provisions of SOX. Current accommodations
provided by the SEC to Level II and Level III ADRs are highlighted
in the shaded cells of Exhibit
Movements of ADRs in Response to SOX Compliance Requirements
following analysis focuses on Level II and III ADRs because
they are subject to full SOX compliance, just like their
domestic counterparts. Exhibit
4 charts the new cross-listings of Level II and III
ADRs on the American Stock Exchange (AMEX), Nasdaq, and
the New York Stock Exchange (NYSE), annually from January
1, 1985, to December 31, 2005, and all domestic common-stock
listings on the same exchanges over the same period. The
data were obtained from JPMorgan Chase and Company.
in cross-listings. The increase in new U.S.
listings and new cross-listings in the mid-1990s was likely
due to the positive general economic environment in the
United States during that period. Note also the spike in
new ADR cross-listings and U.S. listings in 1996, coinciding
with the peak of the hot IPO market. The largest annual
number of new Level II and III ADR cross-listings also occurred
ADR cross-listings significantly declined after 2000. A
decrease from the record-setting new cross-listings of 2000
would be expected, and is evidenced by the 34 new cross-listings
in 2001, a number more in line with the pre-2000 increase
in new listings. For example, 2003 saw only 12 new cross-listings
on the major U.S. exchanges, the lowest number of new cross-listings
since 1989. In addition, new Level II and III ADR cross-listings
in 2004 and 2005 were at their lowest level since 1992.
But what about companies already cross-listed? If SOX compliance
costs do indeed outweigh the benefits, then listed firms
would be withdrawing from the U.S. market.
in delistings. To better understand the impact
of SOX on cross-listed companies’ decisions to delist
from the U.S. exchanges, the authors charted the raw number
of domestic delistings on the major U.S. exchanges (AMEX
and Nasdaq) versus those of Level II and Level III ADRs
from 1987 to 2005, in Exhibit
increase in delistings during 2000 was likely due to the
deflation in the market value of the U.S. stock market.
A return to normalcy after the roaring 1990s would be expected,
but a noticeable shift occurred in 2002: The number of ADR
delistings began to increase while the number of domestic
delistings began to level off and actually fell in 2005.
This provides some evidence that SOX has had a chilling
effect on the decision of foreign companies to stay listed
in the U.S.
examine more closely the relationship between new ADR listings
and new U.S. security listings on the major U.S. exchanges,
the authors calculated the ratio of the two. The authors
calculated a similar ratio for delisted stocks. The cross-listing
and delisting ratios allow for a comparison of trends in
ADR cross-listings and delistings that accounts for general
U.S. market trends. For example, if SOX has also decreased
new domestic listings or increased domestic delistings,
the ADR/domestic cross-listing and delisting ratios will
capture these influences.
seen in Exhibit
6, the new cross-listing/new domestic listing ratio
reaches its maximum value of 0.165 in 2001. Note the pronounced
decline in the new cross-listing/new domestic listings ratio
from 2002 to 2005. The ratio decreased from 2001 to 2005,
with the 2005 value reaching a 10-year low.
the other hand, the delisting ratio increases in each year
over the 2002-to-2005 period. The ratio almost doubles,
increasing from 0.047 in 2000 to 0.085 in 2005. This suggests,
after the passage of SOX, foreign companies are choosing
to delist at an increasing rate compared to their domestic
counterparts. The increase in foreign delistings, together
with the decrease in new cross-listings, provides evidence
that SOX has weakened the competitiveness of the U.S. as
a cross-listing venue.
is the right time to look at SOX’s impact on international
companies’ willingness to cross-list on the major
U.S. exchanges and their propensity to delist from U.S.
exchanges. The authors’ analysis indicates that the
passage of SOX has had a detrimental impact on international
companies’ decisions whether to cross-list in the
United States. The authors find that new ADR cross-listings
relative to new domestic listings are at their lowest level
in 16 years. This finding, coupled with the fact that ADR
delistings relative to domestic delistings are at their
greatest level in the past 16 years, reinforces the belief
that SOX has had a chilling effect on cross-listings in
the United States. Although the authors caution that a definitive
answer to questions surrounding the impact of SOX on delisting
and cross-listings can come only after many years of careful
analysis, the preliminary data seem to suggest a negative
impact on the competitiveness of U.S. exchanges in the global
Zhu, PhD, is an assistant professor in the department
of accounting, and Ken Small, PhD, CFA, FRM,
is an assistant professor in the department of finance,
at the Sellinger School of Business and Management at Loyola
College in Maryland, Baltimore, Md.