ADRs Explained — How to Invest in Foreign Companies on US Stock Exchanges

You want to invest in a well-known Japanese technology firm or a large European consumer goods company. The problem: their shares trade on foreign exchanges, in foreign currencies, with foreign settlement procedures. For most individual investors, buying shares directly on a foreign exchange is cumbersome, expensive, or simply inaccessible through a standard US brokerage account.

This is the problem that American Depositary Receipts — commonly known as ADRs — were designed to solve. ADRs are one of the simplest and most widely used mechanisms allowing US investors to own shares of foreign companies without ever leaving the familiar territory of US exchanges, US dollars, and standard brokerage accounts.

Disclaimer: This content is for educational purposes only and does not constitute financial or investment advice. International investing involves additional risks including currency, political, and regulatory risk. Always consult a qualified financial advisor before making investment decisions.

What Is an ADR?

An American Depositary Receipt is a certificate issued by a US bank — known as the depositary bank — that represents ownership of shares in a foreign company. The depositary bank purchases actual shares of the foreign company on its home exchange, holds those shares in custody, and then issues ADR certificates in the United States. Each ADR corresponds to a specific number of the underlying foreign shares (which may be one share, a fraction of a share, or multiple shares, depending on the arrangement).

From the perspective of a US investor, buying an ADR looks and feels like buying any other stock. ADRs are quoted in US dollars. They trade on US exchanges or over-the-counter markets during US trading hours. You buy and sell them through your regular brokerage account. The settlement follows standard US market conventions.

ADRs were first introduced in the 1920s as a way to make it easier for American investors to participate in foreign markets. Today, hundreds of foreign companies from dozens of countries have ADR programs in the United States, spanning industries from technology and energy to consumer goods and finance.

The Three Levels of ADR Programs

Not all ADRs are equal. The Securities and Exchange Commission (SEC) has established a tiered framework for ADR programs, with each level carrying different requirements, privileges, and investor protections.

Level I ADRs

Level I is the simplest and least regulated tier. Level I ADRs trade over the counter (OTC) — meaning they are not listed on a major US exchange like the New York Stock Exchange or Nasdaq, but rather on less formal OTC markets.

For Level I programs, foreign companies are not required to meet full SEC reporting standards. They do not need to file reports in compliance with US Generally Accepted Accounting Principles (GAAP). Disclosure requirements are minimal. This makes Level I easier for foreign companies to establish, but it means investors have access to less standardized information.

Level I ADRs are typically used by companies that want some US investor access without the full regulatory burden. Because they trade OTC rather than on major exchanges, they may have less liquidity and wider bid-ask spreads than exchange-listed counterparts.

Level II ADRs

Level II ADRs are listed on a major US exchange — the NYSE or Nasdaq. This step up in prestige comes with a meaningful step up in regulatory requirements. Companies with Level II programs must register with the SEC and comply with SEC reporting requirements, though they may still report under international accounting standards rather than US GAAP in some cases, with reconciliation provided.

Listing on a major exchange brings greater visibility, higher liquidity, and greater investor confidence in the quality of disclosed information. Many of the large, well-known foreign companies whose ADRs are widely held by US investors operate at Level II.

Level II programs do not allow the foreign company to raise new capital from US investors — they can only list existing shares.

Level III ADRs

Level III is the highest tier and carries the most stringent requirements. Level III programs require full SEC registration and must meet comprehensive SEC reporting and disclosure standards.

The key distinction that elevates Level III above Level II is that Level III programs allow the foreign company to raise new capital by offering shares to US investors — a public offering in the US markets. This is the path a foreign company takes when it genuinely wants to access US capital markets, not just provide US investors a way to buy existing shares.

The additional regulatory burden at Level III — ongoing compliance with SEC rules, more rigorous disclosure requirements — means these programs are typically pursued by larger, more established foreign companies for which the access to US capital justifies the compliance cost.

What Investors Actually Receive (and Don't Receive)

Understanding what you get — and what you do not get — with an ADR is important before investing.

You get equity exposure. Economically, owning an ADR gives you the equivalent of owning the underlying foreign shares. If the foreign company's stock rises, your ADR value generally rises proportionally (subject to currency effects). You participate in the company's earnings growth, buybacks, and overall equity performance.

You receive dividends — but with complications. When the foreign company pays dividends, those dividends are initially paid in the local foreign currency. The depositary bank converts them into US dollars and distributes them to ADR holders. However, foreign governments often withhold taxes on dividends paid to foreign investors. The withheld tax reduces the dividend you receive. In some cases, US investors can reclaim part of this withholding through tax treaty provisions or foreign tax credits on their US returns, but the mechanics can be complex and worth reviewing with a tax professional.

You still bear currency risk. Despite the convenience of trading in US dollars, ADR holders are not insulated from currency risk. The underlying foreign shares are denominated in the foreign currency, and the value of your ADR in dollar terms is affected by exchange rate movements between the foreign currency and the US dollar. A weakening foreign currency reduces the dollar value of your ADR, independent of the company's stock performance in local terms.

You typically cannot vote. ADR holders often have limited or no voting rights on corporate matters. The depositary bank, as holder of the actual shares, may vote on shareholders' behalf — or shareholders may be able to provide voting instructions in some programs — but voting access is generally less straightforward than with direct US stock ownership.

ADRs vs. Buying Foreign Shares Directly

For many individual investors, ADRs offer a more practical route to international equity exposure than buying shares directly on foreign exchanges. The benefits of ADRs include:

• Trading in US dollars through a standard brokerage account
• US market hours and standard settlement procedures
• No need for a foreign brokerage account
• Regulatory oversight by the SEC (particularly for Level II and Level III programs)

The trade-offs include potentially less liquidity than the underlying foreign market for some ADRs (particularly Level I), foreign tax withholding on dividends, and the ongoing currency exposure that persists despite the dollar-denominated trading.

For investors analyzing individual foreign companies, ADRs represent the most accessible and lowest-friction entry point available through US markets.

Actionable Takeaways

• Understand what an ADR is. It is a US bank-issued certificate representing ownership in a foreign company's shares, trading in US dollars on US markets. Economically, it gives you equity exposure to the underlying foreign company.
• Know the three levels. Level I trades OTC with minimal SEC reporting requirements. Level II is exchange-listed with SEC registration and reporting. Level III adds the ability to raise new capital from US investors with full SEC compliance.
• You still carry currency risk. The dollar-denominated trading price is convenient, but the underlying value tracks the foreign currency. Depreciation in that currency reduces the ADR's value in dollar terms.
• Watch for foreign tax withholding on dividends. Dividends from ADRs are converted from foreign currency and paid in dollars, but foreign withholding taxes are typically deducted. Explore whether foreign tax credits apply to your situation.
• Use ADRs to research internationally. ADRs for Level II and Level III companies offer SEC-registered, English-language disclosure, making fundamental research more accessible than navigating purely foreign-exchange-listed companies.

Ready to research global stocks? Use the free screener at valueofstock.com/screener to find quality companies worth analyzing.

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Disclaimer: This content is for educational purposes only and does not constitute financial or investment advice. The examples used are for illustrative purposes only.

By Harper Banks