ADR RULES:

How American Are American Depositary Receipts? ADRs Rule 10B-5 Suits, and Morrison v. National Australia Bank
Vincent M. Chiappini

Abstract
Over the previous several decades, federal courts employed two teststhe conduct test and effects testto determine whether a securities fraud suit with foreign elements was sufficiently connected to the United States to proceed in American courts. In its 2010 decision in Morrison v. National Australia Bank Ltd, the U.S. Supreme Court held that only domestic transactions may be subject to securities fraud suits. The Court then created a bright-line test to determine which transactions were domestic. Unfortunately, the Courts resultant transactional test was not the model of clarity that it hoped to be. In particular, American Depositary Receipts (ADRs) frustrate the Courts quest for clarity because, as foreign securities attempting to transform themselves into domestic securities, they occupy a borderland that is difficult to reconcile with Morrisons transactional test. This Note analyzes the reasoning ofMorrison as well as the district court cases that have implemented the Courts transactional test. Based on these cases, this Note argues that the determination of whether the purchase and sale of ADRs qualifiy as domestic transactions should depend on the extent to which the issuer has purposefully entered the U.S. market and its regulatory system.

Recommended Citation
Vincent M. Chiappini, How American Are American Depositary Receipts? ADRs Rule 10B-5 Suits, and Morrison v. National Australia Bank, 52 B.C.L. Rev. 1795 (2011), http://lawdigitalcommons.bc.edu/bclr/vol52/iss5/5

What is the difference between ADR and GDR?

Both ADR and GDR are depository receipts, and represent a claim on the underlying shares. The only difference is the location where they are traded. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR.

How can you use an ADR / GDR?

ADRs and GDRs are not for investors in India they can invest directly in the shares of various Indian companies. But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian financial market since ADRs and GDRs are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts!

Which Indian companies have ADRs and / or GDRs?

Some of the best Indian companies have issued ADRs and / or GDRs. Below is a partial list. Company Bajaj Auto Dr. Reddys HDFC Bank Hindalco ICICI Bank Infosys Technologies ITC L&T MTNL Patni Computers ADR No Yes Yes No Yes Yes No No Yes Yes GDR Yes Yes Yes Yes Yes Yes Yes Yes Yes No

Ranbaxy Laboratories Tata Motors State Bank of India VSNL WIPRO

No Yes No Yes Yes

Yes No Yes Yes Yes

ADR/GDR rights under RBI lens:

The Reserve Bank of India [ Get Quote ] has fired the first salvo in regulating activity around voting rights related to
global depository receipts and American depository receipts. In a circular issued recently, the RBI has directed all banks that have issued GDRs or ADRs to take prior consent of the RBI before amending any agreement between the banks and the depositories that issue such instruments.

Depository receipts are instruments issued by international depositories, and they represent an interest in the underlying shares held by them in the issuer company. The shares are usually held by a domestic custodian on behalf of the depositories and the depositories in turn issue the depository receipts, which entitle the holder of the receipts to get the underlying shares on demand. The depository receipts themselves, which represent an interest in the underlying securities, are in turn securities that are capable of being listed on international stock exchanges. The RBI has always been sensitive to the voting power of any shareholder in a bank. The RBI has written a law that requires any voting power in excess of 5 per cent in a private bank aggregated across "associated enterprises" - a term defined in the tax laws governing transfer pricing, which encompasses all entities that are under common ownership, management or control - to get prior consent of the RBI. The RBI seems to have studied the practices that have evolved in the market in relation to GDRs and ADRs. The RBI has noticed that in most cases, depository agreements executed between the issuer companies and the depository do not contain provisions that enable voting in any form by the holders of the depository receipts. There are depository agreements that also provide for the depository voting in accordance with directions of the board of directors of the issuer company. Curiously, the RBI has directed banks not to "give cognizance to voting by depositories in contravention of their agreements" with issuer banks. In other words, the RBI will be happy to see depositories vote in accordance with instructions of the banks, where the agreement provides for such voting instructions. The RBI has called for a copy of every agreement between every bank that has raised funds through GDRs and ADRs and its depository. The RBI has also now imposed a requirement on banks to get prior approval from the RBI before they amend any provision of the depository agreement. This is interesting because even the Securities and Exchange Board of India, which is concerned with voting rights in listed companies for purposes of the takeover regulations, has not gone into micro-regulation of voting rights. Acquisitions of GDRs and ADRs are currently exempt from takeover regulations unless the holder of these instruments actually converts these instruments into the underlying shares carrying voting rights. Of course, in the listing agreement, Sebi has insisted on excluding all the shares underlying GDRs and ADRs from the scope of "public shareholding" since in reality, these shares never get traded in India, and, therefore, ought not to count for measuring liquidity of the public float in the Indian market.

However, with the RBI throwing the spotlight on voting rights related to GDRs and ADRs, the doors of Indian regulatory oversight over depository receipts have been opened. Once one Indian regulator opens up an area of oversight, others follow suit.