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As more dollars flow into Asia, businesses in that region continue to find favor among U.S. investors. Direct investments from the United States continued to climb last year as compared to 2003, and most sharply in Japan, which saw an increase of more than 200 percent, according to the U.S. Department of Commerce. China also benefited from American direct investments, with government figures showing a 195 percent increase in 2004 over 2003. And although the total number of U.S. dollars invested in European countries still outpaces American investments in Asia, growth is brisk in the latter part of the world. When some overseas companies comply with the Sarbanes-Oxley Act’s Section 404 next year, it will mark the first compliance deadline for foreign private issuers seeking investment dollars from U.S. markets. These companies also hope the shift will provide still more evidence to American investors that their businesses are worth investing in. But not all companies are going to reap gains from Section 404. Securities law experts say smaller and midsize companies overseas are more likely than larger foreign companies to decide not to list on U.S. markets or even to consider delisting from American exchanges altogether. And experts add that certain companies have made these decisions despite lessons learned from U.S. companies on how to avoid pitfalls they might have otherwise encountered during the compliance process. So what’s behind these companies’ view of U.S. markets? The expense and trouble of compliance with Section 404 are forcing some overseas companies to skip listings on NYSE and NASDAQ, they say, as foreign listing markets in Hong Kong, Japan, Korea and London take more aggressive approaches to compete for their business. But whether complying with Section 404 is a survival match for the financially fit or a major competitive disadvantage for American markets, foreign companies are looking hard at Section 404, and some are adjusting the way they seek outside funding, if at all. “Section 404 is the last and biggest test for public companies,” says David Matheson, a Perkins Coie partner and co-author of “The Public Company Handbook: A Corporate Governance and Disclosure Guide for Directors and Executives.” SOME REQUIREMENTS UNDER SECTION 404 Under the Sarbanes-Oxley Act’s Section 404, companies are responsible for ensuring that the service providers of any outsourced functions have documented their financial processes, have carried out a risk assessment, and have put in place adequate controls over financial reporting, which have been thoroughly tested for their effectiveness. Foreign private issuers fall under Section 404 requirements and are required to file audit reports on its internal control over financial reporting with their annual reports for the first fiscal year ending on or after July 15, 2006. Roughly 1,200 foreign companies are listed on U.S. exchanges. The New York Stock Exchange has 400 foreign issuers, NASDAQ has about 300, and the remaining foreign companies trade on over-the-counter exchanges. ‘IT’S JUST COMMON SENSE’ “A lot of the stuff around SOX isn’t hard,” says Kurt Berney, an attorney and certified public accountant in O’Melveny & Myers’ Shanghai office, where he represents technology, consumer and other companies in mergers and acquisitions, public and private financings, and venture capital transactions. “It’s just common sense.” Still, as foreign private issuers conduct their Section 404 readiness activities, Berney and others say these companies face unique challenges due to particular business environments and regulations in each country, as well as each country’s own corporate culture and language barriers. But this possible culture clash is a mere stumbling block rather than a full-fledged obstacle, and U.S. companies’ prior compliance activities in the United States have made it a bit easier for foreign companies to wrap their arms around SOX. “Foreign private issuers are going to benefit a lot from the learning and experience from both the accounting firms and the SEC having gone through the process with U.S. issuers,” says Carmen Chang, a partner at Wilson Sonsini Goodrich & Rosati, where she specializes in corporate and securities law and is the leader of the firm’s China practice. Chang adds that the SEC has clarified “a lot the issues that I think were problematic” for U.S. issuers. Aided by lessons learned from U.S. companies, as well as by early filings by other foreign private issuers, many overseas companies may find their biggest challenge is not necessarily the complexity of the law, but rather the financial burdens in terms of human and financial capital. “When I’m talking to different Chinese companies, I’m telling them that we can get through the process and it doesn’t have to be so onerous or expensive,” Chang says. SOX SPENDING WILL CONTINUE Even if costs for compliance don’t turn out to be as high as some foreign private issuers originally believed, companies will still incur substantial expenses. Just how much is compliance apt to cost? “A good rule of thumb is that a company should take its audit budget and multiply it by two. That’s not an unrealistic estimate of what 404 compliance will cost you,” Berney says. It’s too early to determine the exact costs of compliance that foreign companies will likely face, but it’s worth noting that compliance involved several millions of dollars in additional expenses for large U.S. companies who had met prior SOX deadlines. For foreign private issuers — both large and small — the cost of compliance could be similarly staggering, with the smaller to midsize companies experiencing a disproportionately sharp financial pang. Then there are the human-capital cost concerns. “The problem with smaller companies is that they don’t have large amounts of human resources,” says Howard Jiang, a New York-based Baker & McKenzie partner whose practice focuses on mergers and acquisitions and securities in both domestic and cross-border transactions. “It is an uphill struggle for these companies because finding the right people, qualified people, and then paying these people, can be a challenge for overseas companies who are not familiar with our situation and why SOX was enacted.” Although SOX-related expenses are expected to decline somewhat with each subsequent reporting deadline, costs are unlikely to drop by a huge amount, says Wilson Sonsini’s Chang. Others agree. “Fees have stickiness to them,” Jiang says. “Compliance is not a one-time cost. But what will happen is that, further down the road, companies might be less likely to enter into certain kinds of transactions” that might have higher costs of SOX-related reporting requirements associated with them. That reluctance to enter into riskier transactions, Jiang says, could possibly lead to less work and lower bills from risk-adverse accounting and auditing firms that assist companies through the compliance process. ‘THE STRAW THAT BREAKS THE CAMEL’S BACK’ For certain companies that find Section 404 too costly or administratively too burdensome, there are alternative methods of funding, which have grown in popularity since the advent of the stricter U.S. requirements. “The downside to SOX, of course, from the perspective of certain overseas companies, is that there is much more disclosure and the costs of compliance are going to go up,” says Perkins Coie’s Matheson. What this means is that listing markets elsewhere — particularly the exchanges in Hong Kong, Japan, Korea and London — are taking advantage of the competitive advantage they now enjoy over the U.S. markets. “Some foreign companies are really looking at 404 being the straw that breaks the camel’s back,” Matheson says. “And it’s bigger than a straw.” Some companies are considering alternative markets to raise capital or deciding to remain private altogether. “There’s still a lot of money offshore willing to invest” in non-U.S. companies, Matheson says, but he warns that the cost of capital may be higher in markets where the compliance standards have some way to go to mirror requirements in the United States. Baker & McKenzie’s Jiang adds that private equity markets are seeing more activity as a result of some smaller to midsize foreign companies veering away from the United States’ strict disclosure requirements. However, despite the growth of funding alternatives, the desire to list in U.S. markets like the NYSE remains strong for most foreign companies although it might be untenable for some. “Listing on the U.S. markets carries a lot of prestige. That has not fundamentally changed,” Jiang says. “For some companies, compliance is a cost they’re willing to pay.” Tommy Sangchompuphen is a licensed attorney and freelance writer based in Minneapolis. He also serves as a bar exam essay instructor for a national bar review course.

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