Regulation And Oversight Related To Foreign Issuers And Their Auditors

Editor: During the PLI web program, you mentioned concerns that foreign issuers had expressed regarding the process for deregistering securities in the United States.

Dudek: On December 2005, the SEC put out proposed regulations to facilitate the process for foreign issuers to exit the U.S. securities registration and reporting system. Those proposals were issued in response to letters we received from European corporate associations and their law firms. We accepted comments on the proposed regulations from the public until February 28, 2006. We received comments from business associations, law firms and corporations and from those in the EU.

The proposals were designed to address concerns foreign issuers had with the current deregistration system. For one, the current system requires companies to demonstrate that the stock being deregistered is held by less than 300 United States holders of record. This is difficult to determine because keeping up with worldwide investors is a daunting task. By the time that a survey is completed, a company would not know if it still remained under the 300 threshold. In addition, some voiced concern that this standard is too low when considering the realities of today's global marketplace. Finally, a foreign issuer is unable to finalize the deregistration process under the current system because a company may be required to report at a later date if it triggers a reporting requirement in the future. This creates a lot of uncertainty for companies since they must continue to monitor the situation in case a duty to report is triggered.

Editor: How do the proposed regulations address these concerns?

Dudek: The proposed rule 12h-6 would set up a new system for deregistration. Rules 12g-4 and 12h-3 would be amended to eliminate the provisions for foreign private issuers. This will leave foreign issuers with two methods for deregistration, either through the current standards for a U.S. company or the proposed 12h-6 provisions.

To deregister under rule 12h-6, a company would have to demonstrate the following criteria. First, it must have a reporting history in the United States for at least two years and be current with all of its reporting requirements. Second, the company may not make any registered or unregistered offerings, whether debt or equity, during the year before filing under 12h-6. There are some exceptions to this requirement including offerings to the company's employees. Third, the company must have more than 55 percent of its market listed through its home country. This provision was included so that investors will continue to have a flow of information despite deregistration in the U.S.

Editor: Do the proposed amendments take into account a company's size?

Dudek: One of the criticisms of the current system is that the 300-holder-of-record requirement provides a one-size fits all system. The proposed regulations establish a benchmark that is not tied to a precise number of U.S. holders of record.

The test requires a foreign company to show that U.S. investors held no more than 5 percent of the company's worldwide public float. There is no examination of the company's trading volume.

A well known seasoned issuer (WKSI), as defined under Rule 405, may deregister under an alternative test. Under this test, it has to demonstrate that U.S. investors held no more than 10 percent of its worldwide public float and that the average trading volume in the U.S. represents no more than 5 percent of the company's average trading volume in its home country.

There is a provision for companies that do not meet the requirements of the new proposal but meet the 300-holder-of-record requirement under the old regulations. They would still be allowed to deregister by demonstrating that they have less than 300 U.S. holders of record.

When making these determinations, there is a safe harbor for companies that rely in good faith on third-party service providers to obtain this information. This means that the company uses the information on a regular basis and it is not compiled solely for deregistration.

Editor: Once a foreign issuer establishes that it can deregister, what steps must it take?

Dudek: If a company is considering deregulation, it can delist at any time. That is a fairly easy process. The company must provide its U.S. exchange, whether it's the NYSE or NASDAQ, with 30-day notice of its intent to dislist. The company must also issue a press release to inform the public prior to filing form 15F to deregister.

For a copy of the proposed regulations and to read the public's commentary on these provisions, visit

Editor: Rhonda, in the September 2004 issue of The Metropolitan Corporate Counsel, we discussed the mission of the PCAOB with William J. McDonough. ( Editors Note: To read this interview visit,36.pdf.) How does the PCAOB's mission extend to foreign accounting firms working with companies issuing securities in the United States?

Schnare: We oversee public company auditors and issue standards for the accounting profession. During our inspections, we look at whether a company has adopted the appropriate accounting standard for the issue under review. The ultimate decision on whether the company adopted accounting practices is made by the Securities and Exchange Commission.

About 12,000 foreign companies with securities in the U.S. have to comply with many of the Sarbanes-Oxley requirements. Foreign subsidiaries of U.S. companies also have to comply with most of the Sarbanes-Oxley requirements. Given these requirements, the accounting firms that audit the financial statements of a foreign private issuer and those that play a substantial role in the audit of a U.S. company must register with our office.

Currently, we have about 688 foreign accounting firms registered with us. They come from 82 countries around the world. With registration, the firm comes subject to our full oversight. That requires an inspection by us every three years. If the firm works with more than 100 U.S. issuers, it is required to undergo an inspection every year. Currently KPMG is the only firm outside the U.S. that falls under that category.

Editor: How do you determine whether an accounting firm plays a substantial role in the auditing process?

Schnare: If the accounting firm takes part in auditing the financial statements of a foreign subsidiary that makes up 20 percent or more of a U.S. company's assets or consolidated financial statements, it plays a substantial role in the auditing process. This is true even if the parent company does not state that it relied on the work or assessment of the foreign accounting firm that worked with the subsidiary.

Editor: Does the PCAOB work with regulators in other countries during its investigations?

Schnare: The PCAOB initiated a dialogue with the European Commission while it was in the process of implementing its own oversight directives. It has since adopted the 8th Company Law Directive which imposes new requirements on public company auditors similar to Sarbanes-Oxley's requirements. We then talked to member-states and several other countries about how we could work together on the oversight of foreign accounting firms that are required to register with the PCAOB.

In June 2004, the PCAOB adopted rules that allow us to rely on the work of a home country regulator if it demonstrates integrity, adequacy, transparency, independence and an enforcement track record in its investigations.

Editor: What steps are taken during an investigation of an accounting firm?

Schnare: We do not examine every single step in the auditing process. We look for areas that present the biggest challenge to the firms and examine those areas. Our officials look at the industry trends for each firm, the number of partners working on each matter and then we determine the weakest links in the process. Those are the areas that we examine.

We also inspect a firm's internal quality control process. We look at how they carry out the work on select auditing engagements. We also look at seven functional areas to measure the firm's quality control.

One of the key factors is tone at the top. The firm should emphasize audit quality and make the necessary expenditures. Also, compensation and promotion of partners should be based on technical competence and not on whether they can bring in big clients to the firm. This combined with our periodic investigations will motivate accounting firms to adhere to appropriate standards.

Published October 1, 2006.