Challenging Foreign Companies in U.S. Courts

ATTORNEY: HEATHER VOLIK | POMERANTZ MONITOR MARCH/APRIL 2020

As Monitor readers are well aware, in Morrison v. National Australia Bank Ltd. the Supreme Court held that the antifraud provisions of the Securities Exchange Act apply only to “transactions in securi­ties listed on domestic exchanges, and domestic transactions in other securities.” But what about so-called ADRs, American Depositary Receipts, which are securities traded in the U.S. that are linked to the price of underlying foreign securities?

ADRs are negotiable certificates issued by U.S. depositary institutions, typically banks, which represent a beneficial interest in a specified number of shares of a non-U.S. company. Some of these ADRs are “unspon­sored,” meaning that they were not created by the foreign issuers themselves, but rather by unrelated entities that purchased stock of the foreign issuer overseas and now want to trade interests in those shares in the U.S.

This issue arose in the case of Stoyas v. Toshiba Corporation, whose shares trade only in Japan; but Toshiba ADRs are traded over the counter in the U.S. When Toshiba disclosed that it had used improper accounting techniques that overstated profits and concealed losses, the price of Toshiba’s shares in Japan dropped sharply, as well as the price of the ADRs in the U.S. When those ADR purchas­ers sued Toshiba in federal court in the U.S., Toshiba moved to dismiss, arguing that it had nothing to do with the sales of the ADRs and that, in any event, sales of those ADRs were not conducted on a do­mestic exchange and could not be considered to be domestic transactions, as required by Morrison. The district court granted the motion, denying leave to amend the complaint on the ground that any amend­ment would be “futile.”

The Circuit Court reversed, holding that an amend­ment to the complaint might not be futile. The defedants sought certiorari with the Supreme Court, which denied the petition after the solicitor general recommended declining review because the purchases were domestic.

Plaintiffs amended their complaint to add more de­tails concerning the nature of the ADRs and where they were purchased. Toshiba then moved to dismiss again, arguing that the plaintiffs failed to allege that Toshiba was involved in a “domestic transaction.” Toshiba ignored much of the complaint and surmised instead that the plaintiffs must have purchased their Toshiba shares on the Tokyo exchange, and then con­verted them into ADRs to trade in the U.S.

In January 2020, the Central California district court rejected Toshiba’s assertion and concluded that the amended complaint supported the contention that transactions actually occurred in the U.S. In reach­ing that conclusion, the court relied on the allegations that the investment manager and broker, the OTC Link trading platform which routed the order, and the re­cording of the transfer of title, were all in New York.

The court also found that the foreign-based fraud was “in connection with” the purchase of those securities. The defendants had argued that Plaintiffs had not shown that “the fraudulent conduct ‘induced’ Plaintiffs to exchange Toshiba common stock for the unsponsored ADRs from Citibank, or that Toshiba had anything at all to do with that transaction.” The court noted that plaintiffs had alleged “plausible consent to the sale of [Toshiba] stock in the United States as ADRs” with pleading that “it is unlikely that [that] many shares could have been acquired on the open market without the consent, assistance or par­ticipation of Toshiba.”

The court also held that there was no strong policy interest in limiting liability of foreign companies. “The nationality of the parties here similarly weighs in favor of strong U.S. interests: Plaintiffs are U.S. nationals and the proposed class is composed of U.S. nationals only. In the absence of an identifiable foreign or public policy interest in relation to the regulation of securi­ties, specifically, the court concludes that the United States has significant interests in regulating securities transactions made in the United States.”

This decision should open claims of liability by U.S. investors against foreign issuers under 10(b), even when the issuers had limited involvement in the issu­ance of the securities in the United States and the mis­statements were made in a foreign country. The deci­sion provides a formula for successful claims against foreign corporations, including alleging the specific connections to the U.S. market that link the foreign issuer to the purchase.