As I noted in a recent post, the securities class action lawsuit pending against Toshiba raises the question of whether or not the U.S. securities laws apply to transactions in unsponsored American Depository Receipts (ADRs). The company’s petition to the U.S. Supreme Court posed the larger question of whether there are exceptions to the second-prong of the Morrison standard holding that the U.S. securities laws apply to domestic transactions in securities. A number of organizations and even governments filed amicus briefs urging the Court to take up the case. However, in a June 24, 2019, the Court denied the company’s petition, sending the case back to the lower courts and, as discussed below, leaving behind several unanswered questions.
Toshiba is based in Japan. Its common shares trades on the Tokyo stock exchange. Toshiba has unsponsored Level I ADRs trading in the U.S. (meaning that Toshiba ADRs were set up in the U.S. by a depositary bank, without Toshiba’s involvement). After Toshiba was involved in an accounting scandal, it was hit with a U.S. securities class action lawsuit. The district court dismissed the lawsuit, holding among other things the OTC (where the Toshiba ADRs trade) is not a national exchange and there was no securities transaction in the U.S. between Toshiba and the ADR investors.
The plaintiffs in the Toshiba lawsuit appealed to the Ninth Circuit, which reversed the lower court’s holding. The appellate court considered the case in light of the U.S. Supreme Court’s 2010 holding in Morrison v. National Australia Bank, which held that the U.S. securities laws apply to “transactions on a national securities exchange” (the first prong) and to “domestic transactions in other securities” (the second prong). While the appellate court agreed that the OTC is not a national exchange (and therefore the plaintiffs’ claims did not meet the first prong of the Morrison standard), the question was whether or not the U.S. trading in the ADRs is a “domestic transaction in other securities” under Morrison’s second prong.
The Ninth Circuit adopted the Second Circuit’s standard in the Absolute Activist Investor case providing that a transaction is “domestic” if “irrevocable liability” is incurred in the U.S. The Ninth Circuit remanded the case back to the district court to allow the plaintiffs the opportunity to plead that irrevocable liability was established in U.S. sufficiently to permit a determination that the Toshiba ADR transactions involved domestic transactions in other securities under the Morrison test.
The Cert Petition
On October 15, 2018, Toshiba filed a petition to the U.S. Supreme Court, urging the court to take up the case and consider the questions raised in the courts below. In framing the question presented, Toshiba asked the Court to consider whether the U.S. securities laws always apply to domestic transactions (as the Ninth Circuit held) or whether there were (as the Second Circuit held in the Parkcentral case) circumstances in which a transaction has features as to make it impermissibly extraterritorial. That is, is it the case that whether a transaction is domestic is necessary in order to determine whether the U.S. securities laws apply but not necessarily sufficient.
Toshiba argued that the Ninth Circuit’s rejection of the Second Circuit’s Parkcentral standard created a split of authority between the federal judicial circuits. Toshiba also contended that the Ninth Circuit’s ruling in effect opened that circuit up as a “new forum” against “any issuer in the world,” regardless of the steps a company may have taken to avoid being subject to liabilities under the U.S. securities laws. Toshiba also argued that the Ninth Circuit’s holding threatens interference with foreign securities regulation.
A number of international trade associations filed amicus briefs in support of Toshiba’s petition, and in addition the Trade and Finance Ministries of Japan and the government of the United Kingdom also filed amicus briefs, urging the court to take up the case in order to prevent extraterritorial application of the U.S. securities laws.
In responding to the company’s petition, the plaintiffs first raised an interesting argument. That is, they said, contrary to Supreme Court practices, the party that had prevailed in the appellate court below was the one seeking to have the Supreme Court take up the case. The plaintiffs made this argument based on the fact that the Ninth Circuit had held that the plaintiffs had not sufficiently alleged whether or not “irrevocable liability” had been incurred in the U.S. and had remanded the case to the district court. The plaintiffs argued that because Toshiba was the prevailing party in the Ninth Circuit, its petition should not be heard by the Supreme Court.
The plaintiffs also argued that there was no split of authority between the Second and the Ninth Circuit. The plaintiffs argued that the Ninth Circuit had expressly applied the Second Circuit’s Absolute Activist standard (that is, the “irrevocable liability” test) which, the plaintiffs contend is the governing standard in the Second Circuit. Even the Second Circuit itself, has not followed the Parkcentral case, which had itself emphasized that its result was the product of a very unusual factual pattern. The plaintiffs also argued that the company’s contention that allowing the Ninth Circuit’s ruling to stand would open the floodgates to litigation against foreign companies is “unfounded hyperbole.”
At the Supreme Court’s request, the U.S. Solicitor General filed an amicus brief in which the government argued that the Ninth Circuit had applied the Morrison standard correctly and that a cert grant was not warranted in part because the Ninth Circuit’s decision had limited significance.
On June 24, 2019, the U.S. Supreme Court entered an order denying without explanation Toshiba’s cert petition.
The Toshiba case will now go back to the Ninth Circuit and from there back to the district court, where the plaintiffs attempt to allege in connection with the Toshiba ADR transactions that “irrevocable liability” transferred in the U.S. in order to establish that the ADR transactions were “domestic transactions.”
The U.S. Supreme Court’s decision not to take up the Toshiba case means that, in the Ninth Circuit at least, a company with unsponsored ADRs trading the U.S. can be held subject to the U.S. securities laws, at least if the claimant can establish that “irrevocable liability” in connection with the ADR transaction was transferred in the U.S.
During the past few months while the Toshiba cert petition was pending, I have had a number of conversations in a variety of locations outside the U.S. where insurance industry professionals and other observers expressed concern that a company that did not sponsor ADRs trading in the U.S. (and thus that did not purposefully avail themselves of the U.S.) could be subject to a liability action under the U.S. securities laws. I can certainly understand the sense of unfairness implicit in this concern.
However, the Morrison case eliminated the “conduct and effects” test that prevailed previously in order to determine whether or not the U.S. securities laws apply. Arguing that a company should not be subject to the U.S. securities laws because it did not sponsor the ADRs is another way of saying there is not enough of, or perhaps not the right kind of, conduct in order to make the application of the U.S. securities laws appropriate. However, Morrison said the U.S. securities laws applies to transactions, not based on notions such as conduct or effects. In that respect then, under Morrison, it is entirely appropriate that the lower courts are asking whether the transaction issues are sufficiently domestic to make them subject to the U.S. securities laws, and not whether or not the company engaged in certain kind of conduct in order for the U.S. laws to apply.
Whether or not my non-U.S. counterparts find this analysis persuasive, it is nevertheless the case that even companies with unsponsored ADRs trading in the U.S. can be subject to liabilities under the U.S. securities laws if the claimants are able to establish that the ADR transactions are sufficiently domestic. It certainly is not enough for a company to avoid litigation simply by contending that it did not sponsor the ADRs that the claimants purchased.
There is another practical question that the Supreme Court’s decision not to take up Toshiba case leaves unanswered, which is whether there are exceptions to the standard under the Morrison’s second prong that the U.S. securities laws as a result of which the U.S. securities laws don’t apply even if a transaction is otherwise domestic. Are there circumstances where a transaction is sufficiently extraterritorial in nature that the U.S. securities laws should not apply even if the transaction is otherwise domestic? Do the U.S. securities laws always apply to all domestic transactions in securities, as the Ninth Circuit held in the Toshiba case, or it is as the Second Circuit said in the Parkcentral case, that the existence of a domestic transaction is necessary for the U.S. securities laws to apply but not alone sufficient?
Anyway, the bottom line here for my many friends in the insurance industry who work on insurance transactions for companies with ADRs trading in the U.S. is that, not only can a company with Level I ADRs trading in the U.S. potentially be subject to a liability action under the U.S. securities laws, but in fact a company with unsponsored ADRs can be subject to a U.S. securities lawsuit, as long as the claimants can show that their transaction in the ADRs was sufficiently domestic. This fact is obviously very important for anyone working with companies that have ADRs trading in the U.S. to understand.