(Reuters) - January is shaping up to be a big month for complex securities fraud questions at the U.S. Supreme Court. I’ve told you about a petition for Supreme Court review in Emulex v. Varjabedian, which raises the question of the correct pleading standard for alleged violations of Section 14(e) – the basis of M&A challenges in federal court – and could prompt the justices to examine whether shareholders have any right to sue over deficient tender offer disclosures. That case goes to conference on Jan. 4. The following week, the Supreme Court is scheduled to conference on yet another securities case with potentially enormous consequences: Toshiba v. Automotive Industries Pension Trust Fund, which poses the question of whether foreign corporations that have no involvement with American Depository Receipts referencing their foreign-listed shares can be sued in the U.S. by ADR investors.
The answer to that question, as the U.S. Chamber of Commerce explained in an amicus brief (2018 WL 6445989) backing Toshiba’s petition for Supreme Court review (2018 WL 5078031), could affect not just the $12 billion market in so-called unsponsored ADRs but – far more significantly – the multitrillion-dollar (yes, trillion with a T) market in derivatives. According to Toshiba, the Chamber and many of Toshiba’s other amici, if the Supreme Court doesn’t step in to reverse the 9th U.S. Circuit Court of Appeals decision in Stoyas v. Toshiba (896 F.3d 933), every foreign corporation whose shares are referenced in securities traded in the U.S. – regardless of whether the corporation has any involvement with those securities – is facing liability to investors.
“The limitless reach of Section 10(b) in the 9th Circuit threatens to significantly increase securities litigation in the United States, an adverse result that this court has found repelling,” wrote Toshiba’s lawyers at White & Case. “Regardless of whatever efforts it undertakes to avoid being subject to U.S. securities laws and litigation, a foreign issuer is now exposed in the 9th Circuit to class-action lawsuits under the Exchange Act based on third-party transactions in the United States.”
Unsponsored ADRs are securities sold by depository institutions, usually banks, that reference common shares traded on non-U.S. markets. Unlike sponsored ADRs, in which foreign issuers contract to sell depository shares on U.S. markets, unsponsored ADRs don’t entail formal participation by the foreign corporation. Companies whose shares are traded as unsponsored ADRs have no reporting obligations to the Securities and Exchange Commission, although the bank or trust company that creates the ADR has to file SEC disclosures. Unsponsored ADRs can reference shares of any foreign company whose stock trades on a foreign exchange as long as the foreign issuer publishes an English-language version of the disclosures required by its securities regulator.
After Toshiba was embroiled in an accounting scandal in 2015, ADR holders brought a securities class action against the company in Los Angeles. U.S. District Judge Dean Pregerson dismissed the case, holding that investors’ claims were precluded under the Supreme Court’s 2010 decision in Morrison v. National Australia Bank (130 S.Ct. 2869) – which, as you know, said federal securities laws presumptively don’t apply beyond U.S. borders - because ADR purchasers did not engage in domestic transactions with Toshiba. In July, the 9th Circuit held that the key question isn’t whether Toshiba issued or authorized the ADRs but where ADR investors bought and sold the securities. If transactions took place in the U.S., the appeals court held, Toshiba can be liable to ADR investors under the Securities and Exchange Act.
“Looking to where purchasers incurred the liability to take and pay for securities, and where sellers incurred the liability to deliver securities hews to Section 10(b)’s focus on transactions and Morrison’s instruction that purchases and sales constitute transactions,” the 9th Circuit held.
The 9th Circuit said its reasoning matched that of the 2nd Circuit in 2012’s Absolute Activist v. Ficeto (677 F.3d 60), which defined domestic transactions as those in which title to a security passes within the U.S. But the Toshiba ruling also acknowledged a subsequent 2nd Circuit ruling, 2014’s Parkcentral Global Hub v. Porsche (763 F.3d 198), in which the 2nd Circuit held that Morrison precluded investors in swap agreements that referenced German-listed Volkswagen shares from suing in the U.S., in part because the swaps were based on shares that traded only outside of the U.S.
The 9th Circuit’s Toshiba decision said the Toshiba ADRs were distinguishable from the VW swaps at issue in the Parkcentral case for a variety of reasons, including that the ADRs were traded on an SEC-regulated platform and the swaps were not. More significantly, though, the 9th Circuit said the 2nd Circuit’s Parkcentral holding was “contrary to Section 10(b) and Morrison itself” because it carved out a class of securities – swap agreements – from statutory text that encompasses domestic transactions “of any security registered on a national securities exchange or any security not so registered.”
As you can imagine, Toshiba and its many amici – including the Japanese and British governments – have characterized the divergent Toshiba and Parkcentral decisions as a split between the two circuits that dominate securities litigation. Here’s how Toshiba described the current state of play: “The 9th Circuit’s holding subjects foreign issuers to Exchange Act claims whenever third parties bring the issuer’s securities into the United States and transact in those securities, or any derivatives thereof, here,” it said in its petition for certiorari. “The resulting circuit split pits the two most important circuits in U.S. securities law against one another in a battle of irreconcilable rules that invites litigiousness and forum shopping in the United States and interference with securities regulation and enforcement abroad.”
The ADR investors, represented by Robbins Geller Rudman & Dowd, initially waived their right to oppose Toshiba’s petition for Supreme Court review, but the justices were sufficiently interested in the case to request a response. In Robbins Geller’s Dec. 12 brief in opposition (2018 WL 6584997), investors argued that the issue of whether Morrison bars claims over unsponsored ADRs referencing foreign-listed securities isn’t ripe in the Toshiba case because the 9th Circuit said it wasn’t clear whether the Toshiba plaintiffs bought and sold their ADRs in the U.S. The brief also said the 2nd Circuit’s Parkcentral decision – the source of the supposed split between the 2nd and 9th Circuits – is an outlier ruling that the 2nd Circuit hasn’t even followed.
In its new reply brief(2018 WL 6788550), Toshiba countered that the split is “express, genuine and irreconcilable,” and that the 2nd Circuit’s Parkcentral ruling has guided other decisions in the circuit as recently as last June.
Securities class actions may not be blockbusters in the eyes of most Supreme Court watchers, but for us securities geeks, January is going to be a big month.
The views expressed in this article are not those of Reuters News.