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CHAPTER 5

FOREIGN
INVESTMENT

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CHAPTER 5

FOREIGN INVESTMENT
Topics for this chapter:
Foreign

Investment Laws and Codes


Supervision of Foreign Investment
Securities Regulations
Enforcement of Securities
Regulation Internationally

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Foreign Investment
Laws and Codes

What is foreign investment?


Ownership by one person of 10 percent of more of the
controlling interest in an enterprise not located in the
persons home country.
Some states have general investment laws that limit the
type or percentage of foreign investment.
Vietnam only allowed JVs until 1987.
Other countries put restrictions on investment in specific
sectors, such as agriculture, technology, tourism or media.
US does not let foreign investors in strategic (defence)
industries.
Some of these laws are incorporated into bilateral
investment treaties (BITs).

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Bilateral Investment
Treaties (BITs)

Define foreign investment and the conditions under


which investors from one state can invest in another
state.
They often contain guarantees for the investors such
as of fair and equitable treatment; protection from
expropriation and to allow for the repatriation of profit.
Many BITs contain international dispute settlement
provisions usually with ICSID.
Currently more than 2,600 BITs.

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National Foreign
Investment Policies

Purpose of national foreign


investment regulations:
1. Promoting local productivity
and technological
development,
2. Encouraging local
participation, and
3. Minimizing foreign
competition in economic
areas already well served
by local
businesses.
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Policies for Regulating


Investment Applications

To achieve these purposes, investment


laws establish basic policies for screening
and regulating foreign investment
applications.
These generally fall into three categories:

1. To encourage investment through incentives


and minimal regulations.
2. To use investment incentives but also to
require local participation quotas.
3. To allow foreign investment subject to local
screening and supervision.

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Regional Investment Policies


Nations in a particular region may agree to
general standards for investment in their region.
One such region is the Association of Southeast
Asian Nations (ASEAN).
This region is a leading recipient of foreign direct
investment (FDI).
ASEAN countries act individually and collectively
to attract investment.
US, Canada and Mexico created the NAFTA.

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ASEAN Investment Incentives

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Screening Foreign
Investment Applications

Most (but not all) countries require the foreign


investor to register with the government and
obtain government approval of the venture.
In many countries, foreign investors register
with a single central agency set up to facilitate
foreign investments. Its internal staff may
evaluate proposals.
In other countries, such as India and Mexico,
the central agency only coordinates other
specialized agencies and departments.
In some countries, such as Brazil, the
evaluation is handled directly by various
departments and agencies.
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Screening Investment Proposals

There are many varied criteria by which countries screen proposals.


Some examples of proposals that will be screened include:
Proposals seeking investment incentives. (Brazil)
Those with a certain percentage of foreign ownership (e.g. 40% or
more in Philippines)
Those that exceed a certain amount of capital (e.g. $5M or majority
foreign ownership - Argentina)
In Australia the FIRB requires approval for foreign investments of
more than $252m that gain a controlling interest of an Australian
business. Approval is on a case by case basis. Foreign ownership
is limited for Qantas to 49% and for Telstra to 35%.
Recall that in 2015 the FIRB (through the Minister) rejected a
proposal for a Chinese company to buy the Kidman pastoral empire
(decision justified for national security reasons).

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Tiered Screening and Special


Screening of Proposals
In some countries, one person or
department will do the screening if
the investment is under a certain
amount.
Specialized agencies screen
investments in natural resourcebased industries:

Oil and hydrocarbons


Minerals
Forestry

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Information That
Must Be Disclosed

a)
b)
c)
d)
e)
f)

Foreign investors must supply screening


agencies with detailed information, such as:
The industry to be established.
A financial plan.
A production scheme showing annual volume
and value of the production.
A services scheme showing what services will
be created.
The owners, the management structure, and
the relative share of local and foreign control

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Evaluation Criteria

a)
b)
c)

d)

Criteria judge conformity with


countrys national development
objectives. The criteria vary
greatly, but generally include:
The impact on the balance
of payments.
The number of jobs created.
The impact of technical know-how and
the training program for indigenous
employees.
The impact on the local market.

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Evaluation Criteria (cont.)


e)

f)

g)
h)

i)

The contribution to the development of less


economically developed zones or regions.
The ratio between foreign and national
capital contribution.
The export diversification and stimulation.
The use of national inputs and components
in the manufacture of the product.
The effect on price levels and the quality of
the product.
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Formal and Informal


Application Process

The investment application submitted by a foreign


investor must demonstrate two things to the local
authorities:
The proposed investment fits the guidelines of
the investment law, and
That the investment agrees with the
investment philosophy of the host country.

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Approval of Foreign
Investment Applications
Approval

or disapproval of an application will


be done by an informal letter unless the
investor asks for an incentive or the investor
is asked to make a concession. In either
case, a formal investment agreement is
needed.
Agreement will be governed by the host
states contract laws.
Disputes will be resolved in host state unless
the parties agree otherwise.
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Case 5-1 (p 249 of text)


Arab Republic of Egypt v. Southern Pacific
Properties, Ltd. et al. (1984) France Court of
Appeals

Southern Pacific Properties (SPP)


entered into contracts with an Egyptian
state-owned corporation (EGOTH) and
the Egyptian government, represented by
the minister of tourism.
Egypt backed out of the contracts which
provided for arbitration.
Court set aside judgment against
E.G.O.T.H.
government because tourism minister
had no authority to bind government.
www.egoth.com.eg/
Burden fell on investor to make sure that en/Index.htm
proper approval had been given for the
investment.

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Business Forms

International investors may be limited by the host


country in the kinds of business forms they are
allowed to use. Most states want foreign investors
to use businesses that:

1. Have local participation


2. Fully disclose their activities to the public

Local participation usually means a joint venture


organized as a partnership or public company.
Percentage of local ownership usually determines
what incentives are available.
When public disclosure is highly valued it is usual
for a public stock company to be set up.

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Limitations on Foreign Equity


Foreign

investment laws
frequently limit the
percentage of equity that
foreigners may hold in
local businesses.

Foreign Investment
Promotion Board (FIPB)
screens all applications for
foreign investment in India.

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In India, the limit is 40%.


In Mexico, it is 49%.
Exceptions are usually
allowed to attract
investors.

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Sectoral Limitations
Foreign

investment is commonly restricted


by particular economic sectors.
Investment laws usually:

Reserve certain sectors of the economy for

exclusive ownership by the state or its


nationals.
Permit a limited percentage of foreign
ownership in certain sectors, or
Define certain sectors where full or majority
foreign ownership is allowed.
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Closed Sectors

Most states do not allow foreign ownership in


certain sectors. Sectors that are often closed are:
Public utilities
Vital or strategic industries

Ex: France reserves broadcasting,

telecommunications, railroads, gas, and electricity to


state agencies or state-owned companies

Industries that are sufficiently developed

Ex: Flour milling in Ireland/leather production in Japan

Medium or small-scale industries that can be


developed by nationals.

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Restricted Sectors

Restricted Sectors states limit


percentage of foreign investment
allowed in these sectors. This is
done to limit foreign influence in
domestic political, economic, and
social affairs.
Ex: Australia limits radio and
television ownership to 35%
(always changing).
Ex: Korea limits ownership in
telecommunications to 49%.

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Restricted Sectors

Restricted Sectors states limit


percentage of foreign investment
allowed in these sectors. This is
done to limit foreign influence in
domestic political, economic, and
social affairs.
Ex: Australia limits radio and
television ownership to 35%
(always changing).
Ex: Korea limits ownership in
telecommunications to 49%.

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Recent changes in
Australia re real estate
From

1 July 2015, foreign persons who hold


Australian agricultural land must now notify
the ATO of their holdings within 30 days of
holding the freehold interest or right to
occupy this land.
In addition, foreigners who own Australian
real estate have to notify the Foreign
Investment Review Board (FIRB) of existing
holdings of Australian residential real estate
or plans to buy such real estate.
This notification requirement does not apply
to new residential property.
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Recent changes in
Australia re real estate
From

2 May 2015 this review power


for residential property is now held by
the ATO.
For purchases of Australian
residential property up to $1m a nonresident now has to pay a fee of
$5,000 and for property valued at
between $1m and $2m there is a fee
of $10,000.
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Foreign Priority Sectors


Sectors of a states economy in which foreigners
are encouraged to invest. Local resources may
be lacking or the investment may help create jobs.
Ex: In Bangladesh, the government invites
investment in many sectors, including:
Electronic equipment, agro-based industry,
cement, rayon, computer software, chemicals
and petrochemicals, frozen foods, and paper
Ex: South Africas priority sectors include:
Automotive industry, marine, rail, and
aerospace, capital equipment, chemicals,
clothing and textiles, mining, and tourism

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Geographic Limitations

A few countries limit the geographic areas in which


foreign investors may conduct business.

Argentina restricts foreign ownership of land and


businesses adjacent to ocean frontiers.
Belize forbids foreign commercial fishing inside its
barrier reef.
Thailand Restricts the purchase of land by
foreigners.
Chile Does not allow foreigners to engage in coastal
trade.

The right of a state to restrict investment in certain


geographic areas is respected by other states in
accordance with the states sovereign authority.

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Case 5-2 (p 257 of text)


Brady v. Brown
(US
Court of Appeals 1995)
Brady and Cardwell (BC) wanted to acquire coastal land

in Mexico.
Foreigners were forbidden from owning property within
50 kilometres of the shore, Mexicos Forbidden Zone.
BC hired Brown, who created contracts under which BC
invested in property through a Mexican company. Due
to problems under Mexican laws with this arrangement
Brown manipulated the transactions by forming
corporations with his family members as majority
stockholders.
Brown then committed fraud and breached his fiduciary
duties of his power of attorney by transferring the
properties to his family members.

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Brady v. Brown

Brown asked U.S. court to apply comity and find that


contracts were void under Mexican law due to a violation
against the land ownership laws and so he did not owe
BC anything.
Court found that comity required that the laws of a foreign
country should be observed and if a contract is entered
into for the purpose of violating another countrys laws it
will not be enforced. However, where there is fraud does
not prevent the court from granting appropriate relief.
BC was therefore able to recover losses from Brown and
his family.

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Free Zones

Free zones are 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.
They are used by states to encourage multinational
enterprises to invest in their economies by making
direct investment.
Free zones are characterized by geographical size
and by the type of activities that may be carried on
within the zone.

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Free Zones
Characterized by Size

Free zones vary greatly in size:


From large multistate regions (e.g. NAFTA)
To small subzones located in a building (duty free
areas)
The largest are called free trade areas (FTAs).
Comprised of two or more states that have agreed to let
each others enterprises carry on trade across their
borders free of tariffs and restrictions.
NAFTA is a free trade area.

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Free Zones
Characterized by Size
State may open up its entire
territory or all its sectors (e.g.
Singapore).
May open up certain regions (e.g.
Chinas Special Economic Zones).
The oldest type of zone is the
free city, an entire port city that
has been opened to international
trade (e.g. Hong Kong until 1997).
The free trade zone (or foreign
trade zone) is a designated
smaller area near a port.

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The Foreign Trade


Zone Board
approves FTZs in
the US. The US has
more than 180
FTZs and 256
subzones.

Case 5-3 (p264 of text)


Nissan Motor Mfg. Corp., U.S.A. v. United
States (US Ct. of Appeals, 1989)
Nissan

imported machinery into the US to


be installed and used in its assembly plant
that was a FTZ.
U.S. Customs said that the equipment
was not merchandise and was therefore
dutiable in the amount of $3M.
Nissan argued that merchandise entered
into a zone becomes subject to duty only
if the merchandise is thereafter sent into
the customs territory of the United States.
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Nissan Motor Mfg. Corp., U.S.A.


v. United States

Nissans argument was rejected.

Court ruled that equipment is outside the


definition of merchandise if it is installed and
operated as opposed to stored, sold, distributed,
graded, cleaned, mixed with foreign or domestic
merchandise, or otherwise manipulated, or
manufactured, as defined in section 3 of the
Foreign Trade Zones Act.

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Free Zone Categories


by Activities

The type of activities that take


place within a free zone
include:

Storage
Distribution
Manufacturing
Retailing

The full range of activities are


allowed in an FTZ, but may be
restricted in a subzone, such
as a single retail building.

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Free Zone Categories


by Activities
Export

processing zones (EPZs) are free


zones in which manufacturing facilities
process raw materials or assemble parts
imported from abroad and then export the
finished product.
For customs purposes, the materials
and parts are treated as if they never
entered the host country.

No tariffs or duties are imposed.


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Free Zone Categories


by Activities
Free

retail zones (duty-free


zones) are areas in
international airports and
harbors where travelers can
buy goods free of taxes.
Bonded warehouse
located at a port of entry,
shippers can store goods
until they clear customs.
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Foreign Investment Guarantees

Host countries provide guarantees to foreign


investors to attract investment. Some important
guarantees include:

Compensation in the event of nationalization


Repatriation of proceeds upon sale of the enterprise
Repatriation of profits and dividends
Repatriation for current income
Repatriation of principal and interest from loans
Nondiscriminatory treatment
Stabilization of taxes and regulations
Convertibility of local currency

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Foreign Investment Guarantees

Constitutional provisions usually deal with


compensation due to foreign investors in the event of:
Nationalization acquisition by a state of
property previously held by private persons or
companies, usually in exchange for consideration.
Expropriation depriving a person or company of
private property without compensation.
Most countries laws require that the taking be in the
public interest and that fair, just, or full
compensation be paid to the owner (e.g. LIAMCO
case- Libya 1977).

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Foreign Investment Guarantees

Foreign investment laws provide guarantees in


addition to constitutional provisions:

Repatriation guarantees 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.
Nondiscrimination guarantees the assurance of
a host state government that foreign investors will be
treated the same way as local investors.
Stability clauses promise foreign investors that
the host government will not change its tax, foreign
exchange, or other legal regime for a certain period
of time.

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Case 5-4 (p271) (1981)-Ad Hoc Tribunal

Arbitration Between Wintershall AG


et al. and the Government of Qatar
Investment

laws and agreements require


that the host state act in good faith on
requests for modifications.
Facts:

Qatar entered into an Exploration and

Production Sharing Agreement (ESPA) with


five foreign companies.
Time limits were built into the agreement
with relinquishment provisions.
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Arbitration Between Wintershall AG


et al. and the Government of Qatar

Claimants did not find oil, but

had not been allowed to drill


in area called Structure A due
to a border dispute between
Qatar and Bahrain.
Qatar would not accept an
alternative proposal relating
to natural gas production
based upon lack of economic
feasibility and so relinquished
the rights.

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Arbitration Between Wintershall AG


et al. and the Government of Qatar
Issues:

Claimants argued that:

Qatar breached ESPA and expropriated

the claimants rights and interests by


Denying them permission to explore for
petroleum in Structure A, and
By failing to agree with claimants on
contractual arrangements for utilization
of natural gas discovered by claimants.
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Arbitration Between Wintershall AG


et al. and the Government of Qatar
Arbitral

Tribunal findings:

There was no breach of the ESPA.

Qatar
had negotiated in good faith. It had no duty
to accept the natural gas proposals.
There was no expropriation of claimants
contractual rights for failing to accept new
proposals for areas outside the Contract
Area.
The notice of relinquishment was ineffective.
The claimants had yet to be allowed to
explore Structure A and Qatar had failed to
inform them of the Bahrain dispute.
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Protection of Subsidiaries

Subsidiary firms are subject


to same obligations as local
firms.

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Protection of Subsidiaries:
Disclosure of Information

All firms are subject to basis disclosure obligations


to protect of the public from fraud and
misrepresentation.
Two basic sets of disclosure rules:
Initial or organizational disclosure rules
Periodic reports to report changes
Firms must register their organizational documents
and publish them in a gazette or newspaper of
general circulation.
Annual reports are either published or filed with a
central agency depending upon the states laws.

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Protection of the Subsidiary


Several countries provide some protection for
subsidiaries from the disadvantageous decisions
of their parent company.
These provisions are meant to preserve the
capital basis and financial viability of the
subsidiary.
Some countries, like Germany, treat the parent
and subsidiary like a combined company,
requiring the parent to compensate the subsidiary
for any disadvantageous effects of its decisions.

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Protection of the Subsidiary

If the parent and subsidiary enter


into a contract of domination:
The subsidiary must set up a
special reserve,
The amount of profits that can
be transferred to the parent
are limited, and
The parent company must
assume the annual losses of
the subsidiary.

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Protection of a Subsidiarys
Minority Shareholders

Corporate laws, securities regulations,


or stock exchange rules grant minority
shareholders appraisal rights.
Appraisal right The right of a
dissenting shareholder to require the
company to purchase his or her
shares at their fair market value.
In some countries, the minority
shareholder can initiate legal action
against decisions imposed on the
subsidiary that are contrary to the
subsidiarys interests.
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Protection of a Subsidiarys
Creditors

Parent companies are sometimes held


responsible for the debts of their subsidiaries.
In the event of liquidation of the subsidiary, the
parents claims against the subsidiarys assets
are often subordinated to those of other
creditors.
Creditors are often entitled to bring actions to
keep a subsidiary from complying with the
instructions from a parent.
The host state may intervene by appointing an
administrator to operate the subsidiary to
protect the interests of the minority
shareholders and local creditors.

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Protection of a Subsidiarys
Tort Victims
A host state may act
on behalf of injured
persons when a
subsidiary causes
injury. Remedies
may be pursued in
local courts and
foreign courts.
The Bhopal case
from India sets forth
this right.

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Case 5-5 (p277)


The Bhopal Case- Indian Supreme
Court, 1989
Enormous amounts of lethal gas leaked from a
storage tank after an employee added water to it
at a Union Carbide India Ltd. plant in Bhopal,
killing more than 3,800 people.
Cases were filed in U.S. courts.
The Indian Parliament passed the Bhopal Gas
Disaster Leak Act, which authorized the Indian
government to take over the claims of the victims.
The government of India brought legal action on
behalf of the victims in the District Court of Bhopal.
The victims filed petitions challenging the
constitutionality of the Bhopal Act.

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The Bhopal Case


The court applied the doctrine of
parens patriae that allows the
state to act as a guardian of
persons under disabilities.
The court held that the
government had a sovereign
interest in securing for its citizens
all the rights guaranteed by the
Indian Constitution.
Natural justice (due process) is
one of those rights.

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Securities Regulations
National

governments regulate securities


transactions. This includes:

Defining the form that securities take


Overseeing the markets in which securities
are traded
Establishing disclosure requirements
Adopting clearance and settlement
procedures
Limiting insider trading
Regulating takeovers

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Securities

A security is
1. A share, participation, or other interest
in an enterprise or other property or
2. A debt obligation.
A Stock or a share is a share in the
ownership of a company that entitles its
owner to rights in the company.

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Securities

Securities can take several forms:


Certificated security A security that is in
the form of a negotiable instrument of the type
commonly dealt in on security exchanges.
Registered security A certificated security
made out to a named owner and registered
on the books of the issuer.
Bearer security A certificated security
made out to bearer. It is not registered on
the books of the issuer.
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Securities

Registered securities are


transferred by
1. Endorsement directly on
the certificate and
2. Delivery of the certificate
The new owner sends the
certificate to the issuer for
registration and to obtain
a new certificate.
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Securities

A bona fide purchaser of a


bearer security acquires
ownership even if the transferor
was not the owner (i.e., stolen).
A bona fide purchaser is
someone who buys a
security in good faith,
pays value, and
is
unaware that
the
transferor
is not the
rightful owner.
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Securities
Securities

do not have to be in a tangible


form. Companies can issue an
uncertificated security whose
ownership is recorded only on the books
of the issuer.

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Securities Exchanges

Securities brokers and dealers group together to


form securities exchanges: Marketplaces where
member brokers and dealers buy and sell
securities on behalf of investor eg. ASX.

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Issuance of Securities

In order to issue securities, the corporation must


prepare and register a prospectus. This is a 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.
The prospectus must be signed by
the officers and directors of the issuer
any promoters and underwriters
In Australia we have renamed our prospectus
documents to a Product Disclosure Statement
(PDS).
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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.

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Depository Receipts

To facilitate foreign trading in shares, brokerage


firms use depository receipts.
A depository receipt is a negotiable instrument
issued by a bank that represents a foreign
companys publicly traded securities and that, in
turn, is traded on a local securities exchange.
It is created by a broker purchasing a companys
shares in its home country, depositing them in a
custodian bank, who then issues the receipt in the
name of a depository bank in another country.

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Case 5-6 (p288) (1998, US Court of


Appeals)
Batchelder v. Kawamoto

Issue: Does the holder of an American Depository


Receipt (ADR) have standing to bring a
shareholder derivative action against a Japanese
corporation?
Batchelder purchased ADRs pursuant to a deposit
agreement that provided that the law of Japan
governs shareholder rights.
Ruling: Holders of ADRs are not shareholders
under Japanese law. Therefore, Batchelder did
not have standing to bring a shareholders
derivative suit against the Japanese company
(Honda).

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Insider Trading Regulations

Insider trading occurs when someone uses material


nonpublic information about a company or the securities
market to buy or sell securities for personal gain.
It is illegal in the US and Australia, but is a normal
business practice in some other countries. In last month a
person was sentenced to 7 years jail for insider trading in
Australia.
An insider is liable for both self-dealing and when he or
she acts as a tipper and a tippee acts on that information,
knowing that it is not available to the public.
Information is material if a reasonable investor would act
upon it.

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Takeover Regulations

Foreign raiders are more successful in


the US but unsuccessful elsewhere
because securities regulations outside
the US are biased against takeovers.
Barriers to takeover attempts include:

1. Restrictions on share transferability


2. Cross-ownership of shares
3. Restrictions on the voting rights of publicly
held shares

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Enforcement of Securities
Regulations Internationally

International cooperation in the enforcement of


securities regulations is a recent development.
US Securities laws have an extraterritorial
application.
In Morrison v NAB (2010) (an action by US
investors over misleading information given to
NAB shareholders) the US court held that the
matter was not subject to US law as it did not
concern US shares or shares in a US company
(even though NAB shares are traded in the US).

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