Supervision of Foreign Investment
Start-Up Standards – The foreign investor whose application has been approved by the host
state is usually subject to some time limit in which to start construction and/or begin operation.
Most countries require investors to submit periodic reports during the start-up period that describe
their progress in importing capital (including capital goods), constructing facilities, hiring and
training personnel, and beginning production.
Operational Reviews – Once a foreign-owned enterprise is in full operation, it is usually subject
to periodic monitoring. This may involve the submission of information (commonly on a yearly
basis) on various aspects of the enterprise’s business activities, plus regular inspections of its
plant, facilities, and records to ensure that it is in compliance with the local investment
regulations and, if appropriate, a specific investment agreement.
If a single central agency is responsible for approving and supervising foreign investments, it will
commonly collect the reports and conduct the inspections. Otherwise, a variety of specialized
agencies may be involved.
Modification of Foreign Investment Agreements – Investment laws usually provide that any
modification to an investment agreement, including an increase or decrease in the size or scope of
a project, has to be approved by the host state.
Investment laws and investment agreements usually require the host state to act in good faith on
requests for modification. This is also the rule applied by courts and tribunals in cases where an
investment law or agreement sets no standard.
Case 5-4: Arbitration Between Wintershall AG et al. and The Government of Qatar
Facts: In 1976, Qatar (respondent) entered into an “Exploration and Production Sharing
Issues: (1) Did Qatar breach the EPSA as to natural gas development? (2) Do claimants have any
rights as to the Structure A area?
Holdings: (1) No. (2) Yes.
Law/Explanation: Qatar did not violate a duty to negotiate in good faith regarding the natural
Order: Qatar’s termination of EPSA is ineffective as to the Structure A area.
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Protection of Subsidiaries – Foreign investors, whether natural persons or companies, are
generally recognized as having the same right to manage a company in a host state as do local
persons and companies.
At the same time, foreigners are not allowed to take advantage of the fact that they are not
physically present in the host state as a way of escaping full responsibility for their investments.
They and the subsidiary firms they establish are subject to the same obligations as local firms. In
addition, they are subject to a variety of special regulations designed to prevent them from
abusing either their local subsidiaries, their subsidiaries’ employees, or their subsidiaries’
creditors.
Disclosure of Information
All firms, whether foreign subsidiaries or domestic enterprises, are subject to basic disclosure
obligations. The reason companies are required to disclose information about their organizational
structure and their activities is to serve one basic purpose: protection of the public from fraud and
misrepresentation.
There are two basic sets of disclosure rules: (1) initial or organizational disclosure reports that
must be made when a company is first organized and (2) periodic reports that require companies
to update changes in their organization and activities.
The detail of information in the disclosure reports varies from country to country, as do the
accounting methods used. The annual reporting procedures also vary.
Publicly traded companies generally have to provide more extensive information in their annual
reports. Privately held companies are usually required to file only limited information.
Foreign-owned corporations in some countries are subject to the same disclosure requirements as
domestic companies. In a few countries, they are also subject to special additional reporting
requirements.
In order to harmonize the information collected by different countries, the International
Accounting Standards Board (IASB) has assumed accounting standard-setting responsibilities
from its predecessor body, the International Accounting Standards Committee.
Compliance with a country’s disclosure requirements is generally enforced both by the agencies
that collect the disclosure reports and by the country’s Department or Ministry of Justice. In
addition to these basic disclosure requirements, many European countries require affiliated
companies to file consolidated financial statements or, as a minimum, to submit information on
the financial status of the entire group.
Protection of the Subsidiary
The laws of several countries provide some protection for subsidiaries from the disadvantageous
decisions of their parent company. In general, these provisions try to preserve the capital basis
and financial viability of the subsidiary.
Protection of a Subsidiary’s Minority Shareholders
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Corporate law, securities regulations, or stock exchange rules often grant minority shareholders
appraisal rights or rights to minimum guaranteed dividends. Appraisal rights are the rights of a
dissenting shareholder to require the company to purchase his/her shares at their fair market
value.
In some countries, a minority shareholder is entitled to initiate a legal action against decisions
imposed on a subsidiary by a controlling parent company if the decisions are manifestly contrary
to the subsidiary’s interests.
Protection of a Subsidiary’s Creditors
Parent companies are sometimes held responsible for the debts of their subsidiaries or, in the
event of liquidation of the subsidiary, the parent’s claims will be subordinated to those of other
creditors. Creditors are often entitled to bring actions to enjoin a subsidiary from complying with
the instructions of a parent. In addition, the host state may intervene, through the appointment of
a temporary or permanent administrator to operate the subsidiary, to protect the interests of the
minority shareholders and local creditors.
Protection of a Subsidiary’s Tort Victims
If a subsidiary injures persons within the host state in tort or in delict, the host state may assume
responsibility for acting on their behalf and pursuing remedies in the local courts and in foreign
courts as well.
Case 5-5: The Bhopal Case
Facts: On December 2, 1984, enormous amounts of lethal gas leaked from the storage tanks of
Issue: (1) Is the legislation lawful? (2) Is it constitutional?
Holding: (1) Yes. (2) Yes.
Law: The doctrine of parens patriae allows the state to act as a guardian of persons under
Explanation: (1) The victims and their representatives were under a disability in that they were
Order: Application dismissed.
Separate Opinion of Judge Singh: India should act promptly to adopt the UN Code of Conduct
Penalties for Noncompliance – Investment laws usually establish a variety of penalties for
foreign investors who violate the law or fail to comply with an investment agreement. Violators
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may be subject to penalties ranging from fines to the suspension of their right to engage in
business or to the revocation of the facilities they were granted.
Securities Regulations
National governments ordinarily regulate securities transactions, which includes defining the
form that securities take, overseeing the markets in which securities are traded, establishing
disclosure requirements to protect buyers and sellers, adopting clearance and settlement
procedures, limiting insider trading, and regulating takeovers.
Securities – A security is (1) a share, participation, or other interest in an enterprise or other
property or (2) a debt obligation. Stock (or an equity security) represents an ownership interest in
a business, and a bond (or debt security) represents an obligation to pay money.
If a security is in the form of the “type commonly dealt in on securities exchanges,” it is called a
certificated security. It is a negotiable instrument that can be transferred by negotiation. If it is
made out to a named owner, it is called a registered security because the issuer must maintain a
register with the names of the owners of such certificates. If it is made out to bearer, it is a bearer
security and no register of owners is maintained.
Where there is a certificate representing the security, transfer can be accomplished by (1)
endorsement directly on the certificate and (2) delivery of the certificate. Bearer securities are
transferred simply by delivery of the certificate.
A bona fide purchaser is someone who buys in good faith, pays value, and is unaware that the
transferor is not the rightful owner. An uncertificated security is one whose ownership is recorded
only on the books of the issuer. Most developed countries authorize companies to use
uncertificated certificates.
Trading in Securities – Most nations limit the persons who may trade in securities. Typically,
these are brokers and dealers who have registered with a commission that oversees traders and
exchanges.
Securities Exchanges – Securities brokers and dealers have grouped together in many countries
to form securities exchanges, which are marketplaces where member brokers and dealers buy and
sell securities on behalf of investors. These marketplaces exist because they make it easier for
securities’ issuers to find investors and for investors to exchange their securities.
The New York Stock Exchange, the Tokyo Stock Exchange, and the NASDAQ Stock Market are
the three largest exchanges in annual trading volume.
Issuance of Securities – In order for a corporation to offer securities to the public, it must
prepare and register a prospectus to accompany the offer. A prospectus is a printed statement
setting out a “full, true, and plain disclosure of all material facts” relating to the securities and the
issuer, such as:
a history of the issuer and a description of its purpose and goals
a description of the issuer’s business and its present and anticipated course
a current financial statement with an explanation of all significant transactions
profits earned and dividends paid for the previous three years
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Prospectuses must be signed by the officers and directors of the issuer and by any promoters and
underwriters who may be involved. By signing, they certify that a prospectus constitutes, to the
best of their knowledge, full, true, and plain disclosure of all material facts relating to the
securities being offered. Finally, to be effective, a prospectus must be registered.
Exemptions from Registration
Certain kinds of securities and certain transactions are exempt from registration. Exempt
securities typically include those issued by governmental bodies, by banks, and by not-for-profit
corporations. Exempt transactions commonly include nonpublic offerings and limited offerings.
Foreign Registration
Securities may be offered on a foreign exchange so long as they are registered locally. Many
countries allow an issuer to use the same prospectus it registered in its home country.
Clearance and Settlement Procedures – Clearance and settlement is the procedure by which a
buyer turns over the purchase price and the seller turns over the securities in a securities
transaction.
A securities transaction is actually a contract to be performed in the future—at the time the buyer
delivers the purchase price and the seller delivers the debt or equity certificate. In the United
States, the National Securities Clearing Corporation (NSCC), a nationwide clearinghouse,
handles the clearance and settlement of all securities traded on American exchanges.
The Depository Trust and Clearing Corporation (DTCC) holds global certificates for publicly
traded firms, and settlement is done simply by debiting the account of a seller and crediting the
account of a buyer on the DTC’s books. It was created to reduce costs and provide clearing and
settlement efficiencies by immobilizing securities and making book-entry changes to ownership
of the securities.
Similar procedures are followed in other developed countries. In most developing countries,
however, the buyer’s and seller’s brokers must get together and make an actual trade. Although
sales are settled within five business days in developed countries, the settlement process can take
several weeks in developing countries.
International Clearance and Settlement
Two international clearinghouses handle the clearance and settlement of securities sold
internationally: Euroclear and Clearstream. The Emerging Markets Clearing Corporation
(EMCC) provides trade matching, clearance, settlement, and risk management services to global
dealers, interdealer brokers, and correspondent clearing firms involved in emerging markets debt
instruments.
Depository Receipts
To facilitate foreign trading in shares, brokerage firms use depository receipts, which are
negotiable instruments issued by a bank that represent a foreign company’s publicly traded
securities and which, in turn, are traded on a local securities exchange.
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A depository receipt is created by a broker purchasing a company’s shares in its home country,
depositing them in a custodian bank in that country in the name of a depository bank in another
country, and then instructing the depository bank to issue the receipt. When the depository bank is
a U.S. bank, the instruments are known as American Depository Receipts.
Depository receipts are convenient because the shares of the company do not have to leave the
home state—it is the receipt that is sent abroad. Additionally, the physical delivery requirements
of many countries can be avoided by trading the receipt on an American securities exchange.
Also, the stock transfer taxes imposed by some home states can be avoided in part because the
stock itself remains registered in the name of the depository bank.
Depository receipts are not identical, of course, to the securities themselves. The law of the state
where an issuer is incorporated sometimes specifically defines the rights of depository receipt
holders. The deposit agreement between the broker, custodian bank, and depository bank may
define the rights of the holders of such receipts.
Case 5-6: Batchelder v. Kawamoto
Facts: Batchelder (B) owned 1,246 ADRs (equivalent to 12,460 shares) in Honda of Japan (HJ).
Issues: (1) Does Japanese law apply to this dispute? (2) Is B a shareholder?
Holdings: (1) Yes. (2) No.
Law: (1) A choice-of-law provision freely agreed to by the parties determines the law that
Explanation: (1) The ADR provided that Japanese law would be applied in any dispute involving
Order: The trial court’s judgment is affirmed.
Insider Trading Regulations – Insider trading occurs when someone takes advantage of material
nonpublic information about a corporation or the securities market to buy or sell securities for
personal benefit.
Some countries regard insider trading as unjust and dishonest. The U.S. prohibitions against
insider trading are found in Section 10(b) of the Securities Exchange Act of 1934 and in the
Securities and Exchange Commission’s Rule 10b-5, which implements Section 10(b) of the 1934
act.
These forbid an insider who has access to material nonpublic information from buying or selling
shares for his/her own account when the person knows that the information is unavailable to the
person or persons with whom he/she is dealing. In addition, a tipper who has inside information
that he/she discloses to a tippee and a tippee who acts on that information, knowing that it is not
available to the public, are both liable for the profits made by the tippee.
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Courts interpreting these provisions have held that information is material when it is such that a
reasonable investor would act upon it, and information becomes public once it becomes available
to the general public.
The United Kingdom’s prohibitions on insider trading are found in the 1985 Company Securities
(Insider Dealing) Act, in particular Chapter 8, Section 1. Individual victims have no civil remedy
in Britain. The materiality of inside information is ascertained by a different standard. The British
law asks whether the information would affect the price of a security. Finally, violation of the law
does not, of itself, make a transaction void.
Japan’s insider trading provisions are found in Article 58 of its Securities and Exchange Law.
Traditionally Japanese law did not view insider trading as improper, and its insider trading
provisions were seldom enforced. France, like Japan, also had a tradition of ignoring insider
trading violations that was brought to an end by scandals implicating some of its senior
politicians. In 1989, it amended its insider trading laws to give the Commission des Opérations de
Bourse (the Stock Exchange Oversight Commission) authority “to require the production of
documents and testimony from any person” and to impose civil sanctions, in addition to its
existing authority to bring criminal charges.
Takeover Regulations – Financiers became actively involved in foreign acquisitions, mergers,
and takeovers in the 1980s. Common barriers to takeover attempts are (1) restrictions on share
transferability, (2) cross-ownership of shares, and (3) restrictions on the voting rights of publicly
held shares.
Countries with an active acquisitions market (U.K. and U.S.) directly regulate the takeover
process. In the United States, the Williams Act attempts to put the contestants on a level playing
field by authorizing the Securities and Exchange Commission (SEC) to issue rules governing
tender offers for securities of companies registered under the Securities Exchange Act of 1934.
Takeovers in the United Kingdom are regulated by the London Stock Exchange’s City Code on
Takeovers and Mergers that is issued by the Exchange’s Panel on Takeovers and Mergers.
Enforcement of Securities Regulations Internationally
In the 1980s, the United States began pushing its major trading partners to enter into cooperative
agreements, and the Council of Europe began work on an insider trading convention. An insider
trading convention within the EU entered into force in 1991 and has been signed by eight nations.
International Enforcement Cooperation – The U.S. SEC was among the first securities
regulators to receive the legal authority to assist their foreign counterparts in investigations of
securities fraud. The SEC can now assist foreign securities authorities in their investigations using
a number of tools, including exercising the SEC’s compulsory powers to obtain documents and
testimony.
Mechanisms for Information Sharing in Securities Enforcement Matters
The SEC has approached enforcement-related information-sharing on a multilateral, bilateral, and
ad hoc basis. Multilateral and bilateral information sharing arrangements operate on the basis of
memoranda of understanding (MOU) between securities authorities. The SEC also uses other
mechanisms to facilitate information-sharing, such as requests to foreign criminal authorities
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through mutual legal assistance treaties (MLATs) administered by the U.S. Department of Justice,
formal letters rogatory between a U.S. court and foreign judicial authorities.
IOSCO Multilateral Memorandum of Understanding
In 2002, the International Organization of Securities Commissions (IOSCO) created a
Multilateral Memorandum of Understanding (MMOU), the first global multilateral
information-sharing arrangement among securities regulators. The MMOU provides for (1)
sharing information and documents held in the regulators’ files, (2) obtaining information and
documents regarding transactions in bank and brokerage accounts, and the beneficial owners of
such accounts, and (3) taking or compelling a person’s statement or, where permissible, a person’s
testimony.
Bilateral Memoranda of Understanding
Before the establishment of the IOSCO MMOU, the SEC signed bilateral information sharing
MOUs with the securities authorities of 20 different countries. Bilateral MOUs have proven
crucial to investigations undertaken by the Commission’s enforcement staff and, as such, the SEC
considers these bilateral arrangements to be an excellent supplement to the information-sharing
mechanism of the IOSCO MMOU.
Ad Hoc and Other Arrangements for Enforcement Cooperation
The SEC has cooperated on an ad hoc basis with foreign regulators with whom it has no bilateral
MOU or who are not yet signatories to IOSCO MMOU.
The Convention on Insider Trading – Sponsored by the Council of Europe, the convention’s
purpose is to assist the regulatory agencies in exchanging information so that they can better
supervise their securities markets. The convention does not attempt to establish uniform
enforcement provisions or sanctions.
The convention allows one state to request the assistance of another in uncovering conduct by an
individual or individuals in the latter’s territory that constitutes insider trading in the requesting
state.
Extraterritorial Application of U.S. Securities Laws – One important example of the many
attempts to apply securities regulations internationally has been the enforcement of U.S. securities
laws extraterritorially. Consideration of this is especially important because U.S. laws apply to a
much wider range of activities than those of any other country.
To ensure that persons operating outside the United States do not avoid these laws, the SEC and
the U.S. Department of Justice (which are responsible for their enforcement) have regularly
instituted suits involving nonresident aliens. This has forced courts to determine if the U.S.
securities laws give them the necessary jurisdiction to hear these cases.
II. Chapter Questions
Approval of Foreign Investment Applications
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1. Students’ answers may vary. One of the possible arguments includes that State X should not be
Import Duties in Free Trade Zones
2. Students’ answers may vary. Some may argue that VAC is not entitled to receive back the
duties collected. U.S. law provides that goods may be brought into an FTZ subzone without the
Modification of Foreign Investment Agreements
3. Students’ answers may vary. Investment laws and investment agreements usually require the
Obligation of Parent for Subsidiary’s Debts
4. Students’ answers may vary. Parent companies are sometimes held responsible for the debts of
Takeover Defenses
5. Students’ answers may vary. Little, Ltd., may engage itself in cross-ownership with a country
Insider Trading
6. Students’ answers may vary. Some may argue that the Country M agency will be successful in
III. Key Terms
Appraisal right—The right of a dissenting shareholder to require the company to purchase his
or her shares at their fair market value.
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Bearer security—A certificated security made out to “bearer.” It is not registered on the books
of the issuer.
Bona fide purchaser—Someone who buys a security or other negotiable instrument in good
faith, pays value, and is unaware that the transferor is not the rightful owner.
Bond—Contractual obligation of a company (or government) to repay the holder the amount
of his or her original investment plus interest at a specified future date.
Bonded warehouse—A facility at a port of entry where shippers can store goods until they
clear customs.
Certificated security—A security that is in the form of a negotiable instrument of the type
commonly dealt in on securities exchanges.
City Code on Takeovers and Mergers—Rules of the London Stock Exchange issued by the
Exchange’s Panel on Takeovers and Mergers that regulate takeover bids.
Clearance and settlement—Procedure by which a buyer turns over the purchase price and the
seller turns over the securities in a securities transaction.
Closed sectors—Sectors of a state’s economy that are not open to foreign investors.
Depository receipt—A negotiable instrument issued by a bank that represents a foreign
company’s publicly traded securities and that, in turn, is traded on a local securities exchange.
Export processing zones (EPZs)—Free zones in which manufacturing facilities are allowed to
process foreign goods and materials for export without paying tariffs or duties either when the
goods or materials are imported or when they are exported.
Expropriation—Depriving a person or company of private property without compensation.
Foreign priority sectors—Sectors of a state’s economy in which foreigners are encouraged to
invest.
Free city—An entire port city that has been opened to international trade.
Free retail zones—Areas in international airports and harbors where travelers can buy goods
free of local sales and excise taxes.
Free trade areas (FTAs)—Geographical areas made up of two or more states that have agreed
to let some or all of each other’s enterprises carry on their trades across and within each
state’s borders free from customs tariffs and other restrictions.
Free trade zone—A free zone located within or near a port city.
Free zones—Geographical areas wherein goods may be imported and exported free from
customs tariffs and in which a variety of trade-related activities may be carried on.
Insider—A person, such as a corporate officer, director, or majority shareholder, who has
access to material nonpublic information about a company or the securities market.
Insider trading—The use of material nonpublic information about a company or the securities
market to buy or sell securities for personal gain.
Material—According to British law, when the price of something (i.e., a security) would be
significantly affected.
Material—According to U.S. law, when something is of significance to a reasonable person
(i.e., an investor).
Nationalization—Acquisition by a state of property previously held by private persons or
companies, usually in exchange for some consideration.
Nondiscrimination guarantee—The assurance of a host government that foreign investors will
be treated the same way as local investors.
Prospectus—Printed statement given to prospective securities investors setting out a full, true,
and plain disclosure of all material facts relating to the securities and the issuer.
Registered security—A certificated security made out to a named owner and registered on the
books of the issuer.
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Repatriation guarantee—The assurance of a host state government that foreign investors will
be able to take out of the state both the investment capital they brought in and the profits they
earned.
Restricted sectors—Sectors of a state’s economy that are not fully open to foreign investors.
Security—A share, participation, or other interest in an enterprise or other property, or a debt
obligation.
Stock—Share in the ownership of a company that entitles its owner to rights in the company,
including a proportionate part of the dividends and, upon liquidation, of the capital assets.
Subzone—A special-purpose free zone associated with, but physically apart from, a free trade
zone, in which limited-purpose trading activities are carried on.
Securities exchange—Marketplace where member brokers and dealers buy and sell securities
on behalf of investors.
Tippee—A person who acts for his or her personal account on information received from a
tipper knowing that the information is not available to the public.
Tipper—A person who has access to material nonpublic information about a company or the
securities market and who discloses it to a tippee.
Uncertificated security—A security whose ownership is recorded only on the books of the
issuer.
Williams Act—Law enacted by the United States in 1968 that authorizes the Securities and
Exchange Commission to issue rules regulating takeover bids.
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