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Investors in american depositary receipts (ADRs, also known as American depositary shares or ADSs) should be aware that the ordinary expectations they would hold with respect to corporate governance issues in American corporations could be quite different when they invest through ADRs in a foreign corporation. Consider the example of a recent public offering by a Taiwanese company, Chunghwa Telecom Co. When it raised $1.5 billion last year in connection with its debut on the New York Stock Exchange (NYSE), it did so through a public offering of newly listed ADRs. Chunghwa informed prospective ADR holders: “You will be more restricted in your ability to exercise voting rights than the holders of our common shares, which may diminish your influence over our corporate affairs and may reduce the value of your ADSs.” Later in the prospectus, Chunghwa also disclosed that unless 51% of all outstanding ADRs were voted the same way on a matter, Chunghwa’s chairman (or his designee) generally would be given a discretionary voting proxy to vote all ADRs-including those for which the ADR holders delivered contrary voting instructions. While the discretionary (or auto) proxies given to Chunghwa may be among the most far-reaching among ADR issuers, the company is not alone in treating ADR holders differently from local shareholders. ADRs, created in 1927, represent an ownership interest in a foreign company’s equity (and in some cases, debt) securities. ADRs typically are issued by a U.S. bank or trust company-commonly referred to as a depositary-which issues negotiable certificates to U.S. and non-U.S. investors in exchange for the deposit of the underlying shares with a local custodian. ADR holders generally may convert their ADRs back into ordinary shares by submitting their ADRs to the depositary for cancellation in exchange for the delivery of the underlying shares. Today, the four principal ADR depositaries are The Bank of New York Co., Citigroup Inc., J.P. Morgan Chase & Co. and Deutsche Bank A.G., with Bank of New York holding the largest market share by a significant margin. ADRs are regularly used by foreign issuers to create liquid U.S trading markets as well as equity compensation for merger and acquisition (M&A) transactions. ADRs may be issued pursuant to either sponsored programs (both publicly traded and privately placed securities) or unsponsored programs (established by depositaries independent of the foreign issuer and rarely created today). Sponsored ADR programs for publicly traded securities are referred to as Level I (traded over the counter and involving minimal Securities and Exchange Commission (SEC) registration); Level II (quoted on Nasdaq or listed on a national securities exchange such as the NYSE or the American Stock Exchange, in each case not in connection with a U.S. public offering); and Level III (quoted or listed following a U.S. public offering and subject to the same Securities Exchange Act of 1934 periodic reporting requirements as Level II ADRs). ADRs are issued in accordance with the terms of a “deposit agreement.” While holders of sponsored ADRs technically are parties to the deposit agreement, the issuer and depositary negotiate the terms and may amend the agreement at any time without the holders’ consent. In practice, little substantive difference exists between the depositaries’ standard form deposit agreements, and there is rarely much negotiation over the terms of ADR-holder voting. It is possible that the underwriters of Level III ADRs will propose changes to the agreement to improve the offering’s marketability. Voting and ADRs Voting requirements applicable to foreign issuers are regulated, in the first instance, by local laws, which often are inconsistent with U.S. practices. As reporting companies under the Exchange Act, levels II and III issuers are subject to a number of the requirements of the U.S. securities laws, including many of the corporate governance reforms mandated by the Sarbanes-Oxley Act of 2002. Most foreign issuers, however, pursuant to SEC rule-making, are exempt from proxy requirements under � 14(a) of the Exchange Act. See Exchange Act Rule 3a12-3 (17 C.F.R. 240.3a12-3). Although the SEC issued a concept release in 1991 asking for comments on whether depositaries should be required to facilitate ADR voting, the SEC has not mandated any such ADR voting measures. See “American Depositary Receipts,” Securities Act Release No. 33-6894, 56 Fed. Reg. 24420 (May 30, 1991). While levels II and III issuers also must comply with applicable stock market and stock exchange listing requirements, the NYSE and Nasdaq regularly acquiesce to local rules and customs. Therefore, ADR voting in practice mostly is a matter of contract between the issuer and the depositary under the deposit agreement. In recent years, large institutional holders of ADRs and market observers have begun to question existing ADR voting practices-both in terms of the procedural restraints and substantive rights. As a case in point, mutual fund giant Franklin Templeton found itself at odds in early 1999 with Enersis S.A., a Chilean power company that was the subject of a $1.5 billion hostile tender offer by Spain’s Endesa S.A. For Endesa’s takeover to proceed, a 75% supermajority of Enersis’ shareholders had to repeal a share ownership cap contained in Enersis’ bylaws. After a concerted effort by Endesa to solicit the support of Enersis’ ADR holders and ordinary shareholders, Enersis announced that the bylaw amendment had failed when only 73.96% of Enersis shares were voted in favor of the proposal. Franklin Templeton held, in ADR form, approximately 1.5% of all Enersis shares. According to Franklin Templeton, its vote incorrectly had been recorded as an abstention despite the fund manager’s notifications to the depositary prior to the voting cutoff that its shares should have been voted in favor of the proposal. Both Enersis and its depositary refused to correct the votes, even though the shareholder meeting itself would take place two days later. Franklin Templeton’s emerging markets manager Mark Mobius was reported to have written in a letter: “We assume that Enersis sponsored an ADS program . . . because Enersis wished to attract U.S. investment in Enersis shares . . . .[W]e would not have purchased Enersis ADSs had we known that they do not carry meaningful voting rights.” See Paul M. Sherer and Craig Torres, “Enersis Vote Angers Franklin’s Mobius,” Wall St. J., March 8, 1999 (quoting a March 3, 1999, letter from Mobius to Enersis). While Endesa prevailed in repealing the bylaw amendment at a shareholders’ meeting a few months later and ultimately was successful with the takeover, it was forced to relaunch its tender offer at substantial additional cost. Endesa and Franklin Templeton learned the hard way that it is extremely difficult to vote ADRs because of compressed voting periods and cumbersome voting procedures-especially as to ADRs held beneficially and not of record with the depositary. ADR voting rights were front-page news in the Wall Street Journal three years later, and similar criticisms were voiced, when BP Amoco denied activist U.S. fund managers an opportunity to place a shareholder proposal on the ballot. As often is the case with ADR programs, BP Amoco did not recognize ADR holders as separate shareholders of the underlying local shares. Absent the funds’ conversion of their ADRs into underlying shares or the backing of 99 ordinary shareholders, the funds were not able to muster the minimum of 100 shareholders necessary to petition the company. See Craig Karmin, “ADR Holders Find They Have Unequal Rights,” Wall St. J., March 1, 2001, at C1. A call for reform Four months after the Wall Street Journal story on BP Amoco, a cross-section of institutional investors took aim at ADR voting reform when the International Corporate Governance Network (ICGN) created a panel to look into the legal frameworks for ADR voting. ICGN is no lightweight when it comes to voting reforms, counting in its membership CalPERS, TIAA-CREF and other large institutional shareholders. In 2002, the ICGN endorsed the report of its ADR Subcommittee of the Cross-Border Voting Practices Committee on the problems of voting ADRs. The report recommended that ICGN focus on removing provisions in deposit agreements that frustrated voting. See Report of the ADR Subcommittee regarding recommendations for work on ADR issues (March 2002), available at www.icgn.org/consultative/032602.html. In February 2004, ICGN published its “Principles for a Model Depositary Agreement.” ( www.icgn.org/documents/PreambleFinalPrinc.pdf). The principles include the following proposed reforms. In terms of notification of shareholder meetings, the principles specify that ADR holders should receive complete voting materials not less than 21 days prior to any shareholder meeting, and issuers and depositaries should provide clear instructions to ADR holders on voting deadlines and procedures (including the procedural requirements for ADR holders to submit shareholder proposals or attend shareholder meetings). The ICGN principles mandate, with respect to voting by ADR holders, that they have the right to vote either directly or indirectly through the depositary and be recognized as shareholders of the underlying shares, that deposit agreements not restrict ADR votes only to cases where an issuer formally requests their votes and that depositaries vote the underlying shares only in accordance with the ADR holder’s instructions and not exercise discretionary proxies. Likewise, the ICGN would do away with “auto” proxies (such as the Chunghwa proxies), which are commonplace in many deposit agreements and give management discretionary authority to vote shares held by ADR holders. The ICGN also calls for transparency by requiring that deposit agreements be made available for review by ADR holders and prospective holders, and that issuers and depositaries disclose the reasons for failing to comply with any of the ICGN principles. The ICGN recommendation that could be implemented the fastest involves basic access to deposit agreements. While deposit agreements are filed as exhibits to SEC forms F-1 and F-6, foreign issuers were not required to file them with the SEC electronically on EDGAR (the SEC’s online filing service) until November 2002. As a matter of transparency and good corporate governance practices, deposit agreements should be posted online by depositaries and issuers, and any amendments should be noticed on issuer and depositary Web sites. Other recommendations will be more of a challenge to implement and may not necessarily be one-size-fits-all remedies. Requiring that ADR holders be given at least 21 days’ advance notice of meetings runs counter to some home market practices (e.g., markets in which shareholders are notified of meetings by newspaper). This said, a few markets already have responded to calls for increased notice periods and other ADR voting rights. For example, in 2000 Brazil required its ADR issuers to provide not less than 15 days’ advance notice of shareholder meetings. Ruling (Instru��o) No. 342, Comiss�o de Valores Mobili�rios (July 13, 2000). Two years later, Brazil’s Securities and Exchange Commission (CVM) advised all Brazilian issuers to provide not less than 30 days’ advance notice of shareholder meetings, and all Brazilian issuers of ADRs representing common shares or preferred shares with voting rights to provide not less than 40 days’ advance notice. According to the CVM, “[t]he recommendation for companies with [depositary receipt] programs aims to allow a greater participation of DR holders in general meetings, taking into account the operational difficulties inherent to the exercise of voting rights by such shareholders.” See CVM, Recommendations on Corporate Governance 2 (June 2002), located at www.cvm.gov.br/ ingl/indexing.asp. Some U.S. market practices may hinder prompt delivery of voting materials; depositaries often point to NYSE and Nasdaq requirements for the advance notification of record dates, a practice that is not common in overseas markets. Electronic voting In the meantime, issuers and depositaries may want to consider the benefits of electronic delivery of voting materials. Progress toward that goal can be promoted by publication of voting materials and forms of proxy on their Web sites. They can better educate holders (especially beneficial holders who hold their shares through brokers and other intermediaries) about voting mechanics through these means. Depositary banks already are taking strides to provide education to foreign issuers on the proxy process, and they have made a genuine effort to communicate on their Web sites information about their ADR programs, including shareholder meetings (see, for example, Bank of New York’s www.adrbny.com and J.P. Morgan’s www.adr.com). Although not included in the ICGN principles, for an added degree of transparency, issuers and depositaries might consider publishing voting statistics (i.e., percentage of ADRs voted, information on any shares voted by proxy, etc.). With respect to substantive rights-whether the ADR holders will be afforded all of the rights of ordinary holders (such as the right to vote on matters, attend meetings and vote shares directly)-many issuers may have the ability to make this change of their own accord while others are constrained by local laws. But it is difficult to argue that ADR holders as a matter of principle should not be entitled to at least the same rights as holders of the underlying shares represented by ADRs. Indeed, some issuers already treat ADR holders at or close to parity with ordinary shareholders. A number of ADR insiders acknowledge that “auto” and other voting proxies are historical creatures of deposit agreements whose time may have passed. Discretionary proxies come in many forms; the Chunghwa proxy mentioned earlier perhaps represents an extreme example. Given the historically low voting patterns of ADR holders (in part a result of the inability of brokers to exercise discretionary voting), some issuers need the ability to count ADR votes for quorum purposes-perhaps the origins of the proxy itself. But there is a vast difference between counting ADR nonvotes for quorum purposes and giving management the ability to vote ADRs. The depositary banks, meanwhile, have taken notice of ICGN’s proposals. J.P. Morgan, for example, published a white paper in March 2004 addressing the ICGN principles. While not endorsing these principles, the white paper makes clear that “more attention by investors and securities regulators are focused on improving the voting rights of investors” and recommends that “non-U.S. issuers consider moving toward practices that increase investor access to the proxy process.” See J.P. Morgan, ADR Proxy Process-Facilitating Investor Participation in Corporate Governance 1 (March 2004), located at www.adr.com/ pdf/ADR_Proxy_030504.pdf. Asked for his reaction to the ICGN proposals, Michael Finck, a managing director with Bank of New York’s ADR programs, wrote to the author as follows: “In general, the mechanism for having ADR holders’ votes represented at an annual meeting is present in all depositary agreements. How successfully that mechanism functions is a compilation of the influences of many parties. The issuer and its articles of association, the depositary bank, the SEC and the Stock Exchange and local regulators play a role. “Attempting to bridge the differences between U.S. proxy rules, customs and practices with a foreign issuer’s is challenging. ADR depositary banks identify these specific differences and comply with them while developing procedures that create a system such that all ADR programs process their voting procedures in a fairly uniform fashion and within the basic customs and practices used in the U.S.,” Finck wrote. Given the high degree of competition among banks for ADR-issuer clients, it seems unlikely that the depositaries independently will (or can) initiate all the changes recommended by ICGN. This said, the reform environment might change if one of the depositary market leaders, such as Bank of New York, were to come out strongly in favor of the ICGN principles. But, as Finck noted, there are many constituencies with a role in ADR programs and voting reforms. For example, the NYSE (on which 70% of listed ADRs trade) could impose more stringent requirements on its ADR issuers. The NYSE has not yet responded to the ICGN principles or otherwise indicated whether it plans to review ADR voting practices. As an interim reform measure, the NYSE might consider requiring issuers to disclose the waivers and exemptions granted to them in connection with their listing agreements and to measure their compliance with an objective set of ADR voting standards (whether based on the ICGN principles or otherwise). The ICGN principles provide a good foundation for the various interested parties to start a dialog on ADR voting issues. Whether the next step is informal discussions or a conference on ADR voting rights, it is time the various constituencies came to the table. Alexei J. Cowett is of counsel to the Tysons Corner, Va., office of Greenberg Traurig, where he focuses on corporate, securities and international matters.

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