Are American Depository Receipts a safe investment?

In essence, an American Depository Receipt (ADR) is a U.S. security that represents ownership in a foreign security. When a foreign corporation that is not listed on a U.S. exchange—and an increasing number of them are—wants to trade stock on a major exchange like the NYSE, it deposits shares in a bank vault and receives a receipt. With this receipt, the company can issue American Depositary Shares, which are denominated in U.S. currency and allow for the dividends and capital gains of the foreign stock onto investors. The shares are traded just like ordinary domestic stocks. Hundreds of foreign stocks, including Honda and Sony, trade on an ADR basis. Firms issue American Depositary Shares to reduce or eliminate some problems inherent to trading foreign securities, notably currency conversions and the transfer of securities overseas.

Intriguingly, ADRs may go the way of pricing stocks in fractions. (Remember how you used to have to buy a share of Exxon at 75 1/8, instead of at $75.09 as you can today?) As the NYSE and NASDAQ become more aggressive, and as foreign companies recognize the value of tapping into U.S. equity markets, more and more companies based outside the U.S. are agreeing to U.S. accounting rules and so are listing on our stock exchanges directly. Until that happens, ADRs are worth knowing about.