So the U.S. Supreme Court held in Morrison that the investors who purchased their shares of a non-U.S. company on a foreign exchange cannot pursue claims under the Exchange Act, but securityholders who purchased American Depositary Receipts (ADRs) in the U.S. can still seek damages under the Exchange Act, right? Not according to a September 29, 2010 decision by Southern District of New York Judge Richard Berman in the Société Générale subprime-related securities class action lawsuit.

The defendants did not even raise the argument, and it may comes as somewhat of a surprise to some observers, but Judge Berman held, applying the U.S. Supreme Court’s decision in Morrison (about which refer here), that not even domestic purchases of SocGen’s ADRs can assert claims under the Exchange Act. As a result, Judge Berman wound up dismissing the entire case, and not just the claims of investors who purchased their SocGen shares on foreign exchanges.

As discussed below, if the Exchange Act does not even apply to domestic transactions in ADRs, the question that immediately arises as to who is left that might be able to assert Exchange Act claims against non-U.S. companies. The answer in many cases may be – well, nobody.

Background and Decisions

Investors had sued the French bank and certain of its directors and officers in 2008 following the revelations of Jérôme Kerviel 4.9 billion euro trading losses and the bank’s disclosures of its own losses from subprime mortgage related investments.

After the Supreme Court issued its opinion in Morrison, the defendants in the SocGen case had moved to dismiss the claims of two the three named plaintiffs. Both of the two were U.S. residents who had purchased their securities outside the U.S. Judge Berman quickly disposed of these claims, ruling (in reliance on, among other post-Morrison cases, the Credit Suisse case and the Alstom decision, about which refer here and here respectively) that the Exchange Act does not reach claims of such so-called "f-squared claimants."

Judge Berman didn’t stop there, but went on to consider the applicability of the Exchange Act to the claims of the third named plaintiff, UFCW, which had purchased ADRs over the counter in the United States. Even though the defendants had not even themselves raised the question, Judge Berman decided sua sponte that Morrison precludes UFCW’s claims as well.

In reaching this conclusion, Judge Berman said:

…even though Defendants do not argue that UFCW’s claims should be dismissed under Morrison, the Court concludes that the Exchange Act is inapplicable to UFCW’s ADR transactions. That is, the Court finds that because "[t]rade in ADRs is considered ‘predominantly a foreign securities transaction,’ Section 10(b) is inapplicable. An ADR ‘represents one or more shares of a foreign stock or a fraction of a share." Accordingly, UFCW’s claims are also dismissed.

Discussion

Judge Berman’s decision seemingly does not depend on the fact that UFCW purchased its ADRs over the counter, rather than on an exchange. His logic instead depends on the fact that what UFCW purchased were ADRs, the acquisition of which, he held, represents a fundamentally foreign transaction. — which appears to suggest that Judge Berman would apply the same analysis even to ADRs purchased on an exchange.

It is fair to say that Judge Berman’s ruling is unexpected Not even the defendants in the case saw it coming. I think it also raises several questions.

First, Judge Berman’s analysis seems to depend on his rather brief review of what an ADR is and the nature of the transaction involved in a domestic ADR purchase. This seems to me like an issue that would have benefitted from full briefing by all parties. Certainly before any other court chooses whether or not to follow Judge Berman, a comprehensive examination of the relation of the purpose and uses of ADRs would seem to be indicated.

Second, and perhaps more importantly, Judge Berman’s analysis of whether or not the Exchange Act applies to UFCW’s ADRs arguably would have benefitted from more detailed consideration of whether the UFCW’s ADR purchases are "domestic transactions in other securities" to which the Exchange Act applies under the second prong of the Morrison standard.

Third, Judge Berman’s conclusion seemingly put domestic ADR transactions in an odd category about which it may be asked – which jurisdiction’s laws apply to these transactions if not U.S. law?. Are ADR purchases transactions without a country? (Or to put it in a less contentious frame, what jurisdiction’s securities laws make more sense than those of the U.S. to apply to ADR transactions in the U.S.)?

To the extent it is (if ever) conclusively established that the Exchange Act does not even reach domestic ADR transactions, that holding would represent a significant blow to the U.S. securities class action plaintiffs’ bar, as it would eliminate in many instances all or virtually all of the claims that had seemed to be left after Morrison.

If domestic purchasers of ADRs cannot assert claims under the Exchange Act, there would be very few if any holders of securities of many foreign domiciled companies who could assert Exchange Act claims. One wonders whether Judge Berman’s holding could spell the end (or virtual elimination) of many of the current securities cases pending against foreign companies – not only cases such as Vivendi, where plaintiffs won a jury verdict on the issue of liability, but also in more recently filed cases such as those initiated against BP and Toyota.

Not only would that seem to dramatically narrow, if not eliminate, what claims seemed to remain against foreign domiciled companies in the wake of Morrison, but it could drastically limit opportunities for security holders of non-U.S. companies to file future lawsuits under the Exchange Act.

The Morrison decision itself was a surprise, now Judge Berman seems to have compounded that surprise by taking Morrison in a completely unexpected direction. Of course, where it will all lead remains to be seen. I think more will be heard on the issues Judge Berman has raised.

I have in any event added the SocGen decision to my running tally of subprime and credit crisis related lawsuit dismissal motion rulings, which can be accessed here.  Special thanks to a loyal reader for supplying a copy of the SocGen decision.