On January 14, 2019, the United States Supreme Court invited the Solicitor General to file a brief expressing the views of the United States in connection with a pending petition for writ of certiorari regarding whether, in determining if Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) may apply to a securities transaction—including one involving American Depositary Receipts (“ADRs”) which are not sponsored by the foreign issuer and are traded on over-the-counter markets—it is sufficient to show that the transaction itself was domestic. Toshiba Corp. v. Auto. Indus. Pension Trust Fund, et al., No. 16-56058 (Jan. 14, 2019). Under the Ninth Circuit decision for which review is being sought, a foreign issuer that has no involvement in establishing or selling the ADRs can be subject to Section 10(b) as long as the plaintiff purchased or sold the ADRs in a domestic transaction. As noted by the defendant and various amici in support of the petition for certiorari, the Ninth Circuit’s holding significantly extends the extraterritorial application of Section 10(b) to non-U.S. companies which have not elected to avail themselves of the U.S. capital markets.
The Ninth Circuit’s approach appears to be in tension with the concerns expressed by the Supreme Court in the seminal case of Morrison v. Nat. Aust. Bank. In Morrison, the Court emphasized the importance of the presumption against extraterritoriality of U.S. statutes and held that Section 10(b) and SEC Rule 10b-5 only apply to (i) the purchase or sale of a security listed on a U.S. securities exchange, or (ii) the purchase or sale of any other security in the United States. 561 U.S. 247 (2010).
Since Morrison, lower courts have addressed its rule that Section 10(b) only applies to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities” (id. at 267) in various contexts. The transnational nature of transactions involving ADRs, in particular, has given rise to a number of decisions concerning the applicability of Section 10(b). ADRs are negotiable certificates issued by a U.S. depositary institution, typically banks, which represent a beneficial interest in a specified number of shares of a non-U.S. company. They allow investors in the United States to invest in foreign companies and facilitate access to the U.S. capital markets. ADRs can be traded on U.S. exchanges, such as the New York Stock Exchange, or on over-the-counter markets, such as the Over-the-Counter Bulletin Board. Unsponsored ADRs are registered by depositary institutions with the Securities and Exchange Commission (“SEC”) without the foreign company’s participation, whereas sponsored ADRs are jointly registered by the depositary institution and the foreign company.
Courts have repeatedly held that Section 10(b) claims based on ADRs listed on a domestic exchange are permitted under Morrison. The law is more unsettled concerning whether Section 10(b) claims can be brought on the basis of transactions related to ADRs or other instruments that are not listed on a U.S. exchange. The Morrison court did not define the scope of “domestic” transactions. In two significant cases, the Second Circuit has (i) set forth a test to determine if the transaction is domestic for purposes of Section 10(b) application (Absolute Activist), and (ii) held that, in any event, finding that a transaction is domestic is not sufficient to conclude that Section 10(b) applies to the transaction, if the claims are “so predominantly foreign as to be impermissibly extraterritorial” (Parkcentral). The Second Circuit has held that a transaction is domestic “if irrevocable liability is incurred or title passes within the United States.” Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 62 (2d Cir. 2012). Numerous courts, including the Third Circuit, have adopted the “irrevocable liability” test.
The Second Circuit has further held that a domestic transaction “is not alone sufficient to state a properly domestic claim under [Section 10(b)].” Parkcentral Global Hub Ltd. v. Porsche Auto Holdings SE, 763 F.3d 198, 215 (2d Cir. 2014). In Parkcentral, the Second Circuit held that a suit by investors in “securities-based swap agreements” relating to the stock of Volkswagen AG, a German corporation, “impermissibly [sought] to extend § 10(b) extraterritorially.” Id. at 201-02. The Porsche defendants allegedly made fraudulent statements about Porsche’s intentions with respect to Volkswagen stock, but Porsche was not alleged to be a party to the swap agreements or to have participated in the market for such swaps in any way. The court concluded that, even if the purchase or sale of the swap agreements was domestic, “the imposition of liability under § 10(b) on these foreign defendants with no alleged involvement in plaintiffs’ transactions, on the basis of the defendants’ largely foreign conduct, for losses incurred by the plaintiffs in securities-based swap agreements based on the price movements of foreign securities, would constitute an impermissibly extraterritorial extension of the statute.” Id. at 216, 201.
In Toshiba, the Ninth Circuit held that the purchase and sale of unsponsored ADRs traded on an over-the-counter market could qualify as domestic transactions under Morrison and subject the foreign issuer (to whose securities the ADRs refer) to Section 10(b). Stoyas v. Toshiba Corp., 896 F.3d 933 (9th Cir. 2018). The named plaintiffs, U.S.-based funds, had made over-the-counter purchases of unsponsored ADRs of Toshiba, a Japanese company with shares trading on the Tokyo Stock Exchange. The district court dismissed the case with prejudice, finding that Section 10(b) did not apply under Morrison because the over-the-counter market was not a “stock exchange” under the Exchange Act, and plaintiffs had failed to allege Toshiba’s involvement in the ADRs at issue. On appeal, the Ninth Circuit first found that the over-the-counter market was not a “domestic exchange” for purposes of Section 10(b). Id. at *24. Then, adopting the Second Circuit’s “irrevocable liability” test, the Court concluded that the complaint did not include sufficient factual allegations to determine where the parties incurred irrevocable liability, but suggested that “an amended complaint could almost certainly allege sufficient facts to establish that [plaintiff] purchased its Toshiba ADRs in a domestic transaction,” noting that plaintiffs, the over-the-counter market, and the depositary banks were all based in the U.S. Id. at *28-29.
The Court rejected defendant’s argument, based on the Second Circuit’s Parkcentral, that a domestic transaction is not sufficient to subject a non-U.S. issuer to Section 10(b) and that the claims should be dismissed because plaintiffs did not allege any connection between Toshiba and the ADRs. The Ninth Circuit stated that the Parkcentral decision was “contrary to Section 10(b) and Morrison itself” because, according to the Ninth Circuit, “[i]t carves out ‘predominantly foreign’ securities fraud claims from Section 10(b)’s ambit, disregarding Section 10(b)’s text.” Id. at *30. The Ninth Circuit further found that Parkcentral was distinguishable on several grounds, including that: (1) Parkcentral involved private swap agreements that did not constitute investments in the company or confer an ownership interest in the referenced securities; (2) the swap agreements were not traded on any exchanges, systems, or platforms regulated by the SEC; (3) the referenced securities were traded exclusively on foreign exchanges; and (4) no allegations were made that the foreign issuer of the referenced securities knew about or facilitated the swap agreements. Id. at *29-30. Regarding defendant’s arguments that applying the Exchange Act to unsponsored ADRs would undermine Morrison’s comity concerns, the court stated this was “not a basis for declining to follow the Court’s clear instructions in Morrison.” Id. at *31. The court found that the complaint did not sufficiently allege a domestic violation of the Exchange Act, but reversed and remanded the case to allow plaintiffs to file an amended complaint. Id. at *31-35.
Defendant submitted a petition for writ of certiorari to the Supreme Court of the United States. Defendant asked the Supreme Court to decide whether a domestic securities transaction is or is not sufficient to subject a defendant to Section 10(b). Defendant argued that by holding that the Exchange Act always applies if the claim involves a domestic securities transaction—even when it involves foreign conduct, has an effect on foreign securities exchanges, and interferes with foreign securities laws—the Ninth Circuit created a circuit split with the Second Circuit over how to apply Morrison’s limitation on the extraterritorial reach of Section 10(b). Defendant further contended that the issue is of significant and immediate importance because the Ninth Circuit’s rule (i) interferes with foreign securities regulation and (ii) may lead foreign issuers to attempt to prevent trading in unsponsored ADRs referencing their stock. Specifically, defendant argued that the Ninth Circuit’s decision “permits application of the Exchange Act to foreign companies that list their securities exclusively on foreign exchanges, have not otherwise entered the U.S. securities markets, had no involvement with the underlying domestic securities transactions, and whose allegedly fraudulent conduct occurred abroad and has been investigated by foreign authorities.” Defendant also contended that the decision could inhibit the ability of U.S. investors to trade in unsponsored ADRs, negatively impacting the market, if foreign issuers seek to limit such trading to avoid securities litigation exposure.
Numerous amici filed briefs in support of the petition—including the Securities Industry and Financial Markets Association, the U.S. Chamber of Commerce, and the Institute of International Bankers—and similarly argued that the Ninth Circuit’s decision impermissibly extends the reach of Section 10(b) extraterritorially, in contravention of Morrison, and could have detrimental effects on non-U.S. companies, the U.S. regulatory system, and the global securities market.
The Supreme Court’s denial of the petition would leave in place a holding that would subject non-U.S. issuers to Section 10(b), in the Ninth Circuit, even if they are not involved in establishing the securities at issue—such as unsponsored ADRs—and do not participate in the securities transactions that form the basis of the alleged claim. The Court’s invitation for a brief from the Solicitor General, however, suggests that the Court may possibly be leaning toward granting the petition. We will continue to closely follow this case.