How one is built. A depositary bank creates ADRs when the foreign company, or an investor who already owns the foreign shares, delivers those shares to the bank or its custodian in the company's home country. The bank issues ADRs in the United States against the deposited shares, and the ADRs then trade on a US exchange or over the counter, clearing through US settlement systems in US dollars. The process runs in reverse too: an ADR holder may surrender the ADRs and take delivery of the underlying foreign shares, which is the mechanism that keeps the ADR price tied to the home-market price. The ratio is set by the program; the SEC's example is that one company's ADR "may represent several shares of the underlying security, while for another company, an ADR may represent a fraction," the point being to land the ADR at a US-typical price.
Sponsored, unsponsored, and what Form F-6 does and does not disclose. A sponsored ADR is one where the foreign company has contracted directly with the depositary bank to handle recordkeeping, shareholder communications and dividends. An unsponsored ADR is set up without the company's cooperation, often by a broker-dealer that wants a US trading market. Either way, the SEC says ADRs "are always registered with the SEC on a Form F-6 registration statement," and the regulation authorizing that form, 17 CFR 239.36, conditions it on the holder's right to withdraw the deposited shares at any time, subject only to temporary delays, fees and legal compliance. But Form F-6 "contains no information about the non-U.S. company." Its disclosure covers the deposit agreement, a form of the certificate and legal opinions. Whether there is any SEC-filed information about the company itself depends on the level of the program.
The three levels, which are a market convention rather than a rule. The SEC's bulletin says "market participants have generally categorized ADRs into three 'levels'" by how far the company has entered the US market. A Level 1 program establishes a trading presence but cannot raise capital; it is "the only type of facility that may be unsponsored and, as a result, may be traded only on the over-the-counter market," and no information about the issuer will be on EDGAR. A Level 2 program lists on a national securities exchange, still cannot raise capital, and requires the company to register with the SEC and file annual reports on Form 20-F. A Level 3 program lists and raises capital, filing a registration statement on Form F-1, F-3 or F-4 and annual reports on Form 20-F. The distinction that matters most to a holder is Level 1 against the other two: a Level 1 ADR trades over the counter and the company may disclose only what its home country requires, while an exchange-listed ADR comes with an SEC annual report, even though the SEC notes that a Form 20-F filer's disclosure "may also not be as extensive or comparable to that of U.S. public companies."
Fees you may not notice. Depositary banks charge holders a custody fee, sometimes called a depositary services fee, for inventorying the foreign shares and running the program. The SEC describes the common collection mechanism: the bank subtracts the fee from the gross dividend, the Depository Trust Company announces both the gross and the net dividend rate, and holders receive the net. When an ADR pays no dividend, DTC charges the fee to the banks and brokers that hold the ADRs, who pass it on to their customers as a line item. Fees are assessed per ADR; the SEC's 2012 bulletin gave as an example a fee ranging from $20 to $50 per 1,000 ADRs, and directed investors to the fee schedule in the Form F-6 on EDGAR, in the section typically titled "Description of American Depository Shares." Banks may also charge for distributing dividends, converting currency and voting.
The tax point that turns on where the ADR trades. A dividend from a foreign company can be a qualified dividend, taxed at long-term capital gain rates, only if the payer is a "qualified foreign corporation," and the qualified dividend page explains the three routes to that status: incorporation in a US possession, eligibility under a satisfactory US tax treaty, or stock that is "readily tradable on an established securities market in the United States." The ADR-specific consequence lives in IRS Notice 2003-71, which defines that third route: "common or ordinary stock, or an American depositary receipt in respect of such stock, is considered readily tradable on an established securities market in the United States if it is listed on a national securities exchange that is registered under section 6 of the Securities Exchange Act of 1934 ... or on the Nasdaq Stock Market." Publication 550 repeats the same test and points to the SEC's list of registered exchanges. So a Level 2 or Level 3 ADR passes the readily-tradable test on its own. A Level 1 ADR, quoted only over the counter, does not meet that definition; the same notice says the Treasury and IRS were "continuing to consider" the treatment of stock listed only on over-the-counter systems, and the current Publication 550 still states only the exchange-or-Nasdaq test. An OTC-only ADR's dividends can still be qualified, but only if the company qualifies through the possession or treaty route, and never if the company is a passive foreign investment company, which the statute excludes outright. Separately, the company's home country may withhold tax from the dividend before the depositary receives it; that withholding is the subject of the foreign tax credit page.
