Foreign Private Issuers: Time to End the Free Lunch?

The Securities and Exchange Commission has decided to take a look. In this article, I’ll discuss the reasons why FPIs enjoy a different disclosure regime, what the data show when it comes to litigation against FPIs versus domestic filers, what the SEC is considering, and what all of this means for D&O insurance for FPIs.

By Foreign, We Mean Foreign

The definition of an FPI is a technical one. To qualify as an FPI, an issuer must:

1. Be organized according to the laws of a foreign country; and
2. Have more than 50% of the voting shares owned by non-US residents, or
3. Meet the US Business Contacts test.

A company fails the Business Contacts test if:

1. Leaders: executive officers and directors are a majority US citizens or residents; or
2. Assets: majority located in the US, or
3. Headquarters: the business is mostly run out of the US.

The clear point is that the SEC wants to limit the benefits of the FPI regime to issuers that are truly foreign. Domestic issuers are expected to comply with the SEC’s normal disclosure regime. 

The Argument for Lower Disclosure Requirements for FPIs

Why would there be a lesser disclosure regime for foreign private issuers compared to domestic issuers? One driver was the desire to have FPIs list their securities on US exchanges. Exchanges are more robust the more listings they have. If the United States wants to attract foreign filers to list on US exchanges, it makes sense to allow them to continue to operate largely under the disclosure regime of their home countries. 

There was also a belief that it is good for US investors to be able to access the securities of FPIs through US exchanges.

Another driver was the belief that FPIs interested in trading on a US exchange were likely to be mature companies that were subject to, and complying with, mature disclosure regimes and exchange requirements in their home countries. 

Hence, the entire regime of separate filings for FPIs was created, such as Forms 20-F and 6-K for ’34 Act filings (equivalents of domestic filers’ Forms 10-K and 8-K) and Forms F-1 and F-4 for ’33 Act filings (equivalents of Forms S-1 and S-4).

More notable than the required filings are the filings and rules that are not required of foreign filers. For example, FPIs are exempt from filing things like 10-Qs, and they are exempt from Regulation FD . . . and that’s just the tip of the freedom iceberg. Being free from these requirements certainly makes it easier and less costly for FPIs to list on US exchanges compared to domestic issuers. 

Who Is Paying for the Free Pass?

Is the regulatory free pass really free? Or is it US investors—exactly the folks the SEC is charged with protecting—who are paying for the free pass?

This is a difficult question to analyze. One way to think about the question might be to consider private litigation against foreign-domiciled versus US domestic public companies. After all, the point of securities litigation against issuers is to bring redress to shareholders who were harmed by a company’s failure to provide appropriate disclosure. 

As we know, not all securities class action suits are righteous. A directional proxy for the number of filed suits that are relatively frivolous is the number of suits that are tossed out by courts on a motion to dismiss. Adding to the number of frivolous cases would be the cases that are withdrawn by plaintiffs after being filed. This leaves cases that go to trial or settle for cash as the cases that are non-frivolous. 

Here is what we see when we break down the percentage of cases that are thrown out on a motion to dismiss, withdrawn, settled, or go to trial between domestic and foreign companies:

The percentages of dismissed, withdrawn, settled, and cases taken to trial are effectively the same between the two groups. 

Is this similarity the result of the differences in the disclosure regimes, reason being that FPIs as a group might be worse actors than domestic filers, but FPIs get away with more since the disclosure requirements are lesser for them? Maybe. 

Perhaps equally likely is the conclusion that, while the disclosure regime for FPIs is less rigorous than for domestic filers, the differences are not that meaningful. 

A third theory could be that it’s actually difficult to sue a foreign company and foreign persons (e.g., effecting service of process is more difficult), so the plaintiffs’ bar is limiting itself to the more egregious cases. 

A fourth theory could be that once a certain level of disclosure has been achieved, requiring more disclosure is not that additive. 

What we are not seeing in the data is a lot more meritorious suits against foreign or domestic companies. 

The natural next question is “what do the settlements look like?” After all, suits that settle, as noted above, are likely suits that had some merit. 

As a general rule, the size of the settlement would be correlated with seriousness of the case.

Here is the breakdown:

Settlements are sensitive to market capitalization, so this data is only a conceptual first cut.

The fact that domestic issuers are settling for larger sums than FPIs jumps off the chart. Is this because the market capitalization for FPIs is so much smaller? No. The median market capitalization of this cohort of domestic issuers is $1.2 billion, compared to $2.6 billion for the FPI cohort.

The SEC Is Here to Protect US Investors

The SEC has decided that it’s time to examine FPIs as a category. To that end, the SEC recently issued a “concept release” in which it is asking for comments on the definition of an FPI as a way to determine if the right population is being afforded the benefits of the FPI regime. 

If it is not, then US investors are not receiving an appropriate level of disclosure from all companies listed on US exchanges.

Inspiring this review of the FPI definition are two observations discussed in a study conducted on FPI trends FPIs from 2003 to 2023 by the SEC’s Division of Economic Risk Analysis (the “FPI Study”):

1. There is an increasing number of FPIs whose securities are only traded in the United States (as opposed to also in the companies’ home countries); and
2. There is an increasing number of FPIs whose country of incorporation is different from where the company is headquartered. 

What about the belief that FPIs would tend to be companies subject to fulsome disclosure regimes in their home countries? According to the SEC’s concept release, this reliance may be displaced. Indeed, the home countries of some FPIs explicitly exempt a company from the home country’s disclosure regime and instead allow the company to merely comply with the disclosure regime of the listing country. The result, of course, is less and not more disclosure for US investors since they are only getting the disclosure required of an FPI without any enhanced disclosures being made in compliance with the FPI’s home country disclosure regime.

Is looking at the definition of FPI, as opposed to reviewing the disclosures required by FPIs, a strange way to approach the issues? That is the point that SEC Commissioner Caroline Crenshaw’s Statement on the Concept Release on Foreign Private Issuer Eligibility makes.

Impact of Changing the Disclosure Regime for FPIs

While change is in the air for the FPI disclosure regime, it is unlikely that the changes will be radical or swift.

It is, however, likely that at least some companies that enjoy providing only limited disclosures as FPIs will end up losing this status and providing more disclosure. 

This is a positive development if one believes more disclosure is always a benefit for investors. If, however, one believes that disclosure requirements for public companies are overblown and overly onerous, one would expect to see at least some foreign filers choose to leave US exchanges. 

The change in disclosure regime will provide the SEC with a golden opportunity to study the quality of the companies that choose to stay or leave US exchanges after new rules are implemented. 

One hopes the SEC, as a responsible regulator, does so. Such a study might provide some good ideas for the optimal level of disclosure to attract and retain quality companies. 

What Will Changes to the FPI Disclosure Regime Mean for D&O Litigation and Insurance? 

Certainly, D&O insurance carriers underwriting FPIs may benefit from increased disclosure. On the other hand, as those of us who study the subject know, more disclosure requirements can also lead to more opportunities for the plaintiffs’ bar to bring frivolous but costly-to-defend securities class action suits alleging disclosure failures. 

Of course, the risk of this type of litigation is exactly why D&O insurance is so important for public companies, be they domestic or FPIs.