Why Asian issuers should not dismiss US offerings

Though the US capital markets are perceived to be the most liquid in the world, the common view is that the new requirements under the Sarbanes-Oxley Act may place the New York Stock Exchange and the Nasdaq Stock Market at a competitive disadvantage compared with non-US stock exchanges in attracting smaller companies. Unlike larger companies with more extensive capital needs or global ambitions, smaller companies may feel that the increased requirements imposed by Sarbanes-Oxley mean the overall costs of listing on a US exchange outweigh the benefits of accessing the US public markets.

It is true that additional requirements have been added to the already challenging process of listing in the US and reporting to the US Securities and Exchange Commission. However, non-US companies, along with their shareholders and advisers, need to examine the listing requirements of the relevant stock exchanges in light of each company's present situation and future strategy before deciding to forgo a listing in the US out of fear of Sarbanes-Oxley.

Recent experience has shown some of the difficulties issuers can encounter in Hong Kong and Shanghai that could be alleviated by instead pursuing a listing on either the NYSE or Nasdaq. Along with these two US exchanges, the main board of the Hong Kong Stock Exchange and the Shanghai Stock Exchange are the ones frequently considered by issuer clients with large China operations.

Process and qualification for listing

Nasdaq is known for being one of the best places to list start-up companies. In contrast, requirements of a three-year track record by both the Hong Kong Stock Exchange and the Shanghai Stock Exchange prevent any company from listing until it has achieved three consecutive years of profitability. This may not occur until many years after incorporation. In addition, the track record requirement of the Hong Kong Stock Exchange also requires that the company must largely be under the same management - with no change in controlling shareholder - during the three years. In periods of market turmoil and restructuring, satisfying these requirements is not easy and parties involved in restructurings in expectation of future listings need to think carefully before assuming that a listing on the Hong Kong or Shanghai exchanges will be available at the right time.

Even in circumstances where a three-year profit record exists, satisfying the financial statement requirements for a Hong Kong listing may also be impossible within three years after some restructurings. In a recent case, a potential investor in a privately held PRC business that had been profitable for the past three years wanted to structure its investment through a newly incorporated Cayman Islands company. The sole asset would have been a majority interest in the PRC company. The intention was to list the new Cayman Islands company on the Hong Kong Stock Exchange as soon as possible. Despite the fact that the PRC company had been profitable for the past three years, the Cayman Islands company was not eligible for listing on the Hong Kong Stock Exchange because it would not be able to independently satisfy the requirement for three years of audited consolidated financial statements. Pro forma financial statements of the company to be listed that would reflect the audited financial statements of the underlying business were not acceptable for listing.

In essence, the Hong Kong Stock Exchange requirement for three years of audited consolidated financial statements means that only restructurings that preserve the historical financial statements of the underlying business can be done within three years before a listing, even if the restructuring does not change the operations of the business to be listed.

Because the Nasdaq does not impose any track record requirement, the Cayman Islands company would be eligible to list on the US exchange. A listing on the NYSE can also proceed in circumstances where pro forma financial statements or financial statements of a subsidiary can demonstrate a three-year profit record that satisfies the exchange's rules, even if the track record is not completely reflected in the audited consolidated financial statements of the company to be listed.

Restrictions after listing

An issuer and its controlling shareholders must also consider what activities or transactions they may wish to pursue after listing to ascertain whether individual stock exchange requirements will restrict or even preclude realizing such objectives.

Both the Hong Kong Stock Exchange and the Shanghai Stock Exchange impose substantive regulation limiting the ability of a company to offer shares soon after listing. Rules in Hong Kong prohibit a company and its controlling shareholders (defined as any shareholder holding 30% or more) from issuing or selling any shares of the company during the first 12 months after listing if such issuance or sale would cause any controlling shareholder to own less than 30% of the company. This prohibition can effectively prevent an issuer and its controlling shareholders from entering into strategic transactions during this time. For example, if the controlling shareholder holds only slightly more than a 30% stake, there will be an insufficient number of shares to allow issuance or sale to a new strategic partner.

The 12-month prohibition would also in many circumstances prevent the company from engaging in any mergers or schemes of arrangements. Companies contemplating listing on the Hong Kong Stock Exchange must consider whether the listing rules provide them and their controlling shareholders with sufficient flexibility to exploit opportunities in the first year after listing that may not be apparent at the time. Neither the NYSE nor Nasdaq imposes special limitations on share issuance by newly listed issuers.

Rules of the Shanghai Stock Exchange and the Hong Kong Stock Exchange both purport to prohibit a controlling shareholder of a PRC company from competing with the company. For the Shanghai Stock Exchange, the prohibition may also be interpreted to extend to shareholders that have a significant influence even if they are not controlling shareholders. This is proving problematic to multinational corporates that are considering investing in PRC companies in expectation of a future listing. If a corporation is already engaged, directly or indirectly, in a business in the PRC, a domestic company in the same line of business in which the corporation takes a controlling stake may not be eligible for listing in either Hong Kong or Shanghai. In addition, a company that is listed on the Shanghai Stock Exchange would be prohibited from selling a controlling or large stake to a company that has a competing business in the PRC.

Both the NYSE and the Nasdaq rely upon the law applicable to the board of directors of the listed company and do not substantively regulate potential conflicts of interest between a company and its controlling or influential shareholders.

The Sarbanes-Oxley balancing act

The initial listing of any company is a momentous occasion. Non-US companies and their controlling shareholders and advisers must consider the operations and future plans of the issuer among the costs and benefits of the listing venue. There is more to this decision than the incremental requirements imposed on US-listed issuers by Sarbanes-Oxley. Many non-US companies, even the smaller ones, will ultimately decide that listing on a US exchange still provides many benefits and opportunities not achievable elsewhere.