Level 1 depositary receipts are the lowest level of sponsored ADRs that can be issued. When a company issues sponsored ADRs, it has one designated depositary who also acts as its transfer agent.
A majority of American depositary receipt programs currently trading are issued through a Level 1 program. This is the most convenient way for a foreign company to have its equity traded in the United States.
Level 1 shares can only be traded on the OTC market and the company has minimal reporting requirements with the U.S. Securities and Exchange Commission (SEC). The company is not required to issue quarterly or annual reports in compliance with U.S. GAAP. However, the company must have a security listed on one or more stock exchange in a foreign jurisdiction and must publish in English on its website its annual report in the form required by the laws of the country of incorporation, organization or domicile.
Companies with shares trading under a Level 1 program may decide to upgrade their program to a Level 2 or Level 3 program for better exposure in the United States markets.
Level II (listed)
Level 2 depositary receipt programs are more complicated for a foreign company. When a foreign company wants to set up a Level 2 program, it must file a registration statement with the US SEC and is under SEC regulation. In addition, the company is required to file a Form 20-F annually. Form 20-F is the basic equivalent of an annual report (Form 10-K) for a U.S. company. In their filings, the company is required to follow U.S. GAAP standards or IFRS as published by the IASB.
The advantage that the company has by upgrading their program to Level 2 is that the shares can be listed on a U.S. stock exchange. These exchanges include the New York Stock Exchange (NYSE), NASDAQ, and the American Stock Exchange (AMEX).
While listed on these exchanges, the company must meet the exchange’s listing requirements. If it fails to do so, it may be delisted and forced to downgrade its ADR program.
Level III (offering)
A Level 3 American Depositary Receipt program is the highest level a foreign company can sponsor. Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies.
Setting up a Level 3 program means that the foreign company is not only taking steps to permit shares from its home market to be deposited into an ADR program and traded in the U.S.; it is actually issuing shares to raise capital. In accordance with this offering, the company is required to file a Form F-1, which is the format for an Offering Prospectus for the shares. They also must file a Form 20-F annually and must adhere to U.S. GAAP standards or IFRS as published by the IASB. In addition, any material information given to shareholders in the home market, must be filed with the SEC through Form 6K.
Foreign companies with Level 3 programs will often issue materials that are more informative and are more accommodating to their U.S. shareholders because they rely on them for capital. Overall, foreign companies with a Level 3 program set up are the easiest on which to find information. Examples include the British telephone company Vodafone (VOD), the Brazilian oil company Petrobras (PBR), and the Chinese technology company China Information Technology, Inc. (CNIT).
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