(Reuters) - A new trial court ruling in a securities fraud class action by holders of Toshiba American Depository Receipts doesn’t just revive investors’ claims. It should also reanimate warnings that allies of the Japanese electronics company presented last year to the U.S. Supreme Court.
Toshiba wanted the Supreme Court to review a ruling by the 9th U.S. Circuit Court of Appeals that gave its ADR holders in the U.S. another shot at pleading their case. Specifically, Toshiba asked the justices to decide if foreign companies can face securities fraud liability in the U.S. for unsponsored American Depository Receipts.
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Toshiba’s petition drew considerable amicus support. Its backers, broadly speaking, urged the Supreme Court to consider the nature of unsponsored ADRs, in which depository institutions (usually banks) create U.S. traded securities that reference common shares traded on foreign exchanges.
Foreign companies sometimes sponsor ADRs to attract U.S. investors, but if ADRs are unsponsored, the company whose shares underlie the securities has no formal role in their creation, nor any reporting obligation to the Securities and Exchange Commission.
So according to Toshiba’s amici - including the governments of Japan and the U.K. and a host of international business groups - allowing ADR investors to sue simply because they bought an ADR in the U.S. would vastly and improperly expand the reach of U.S. securities laws, defying the territorial limits established by the Supreme Court in 2010’s Morrison v. National Australia Bank. The U.S. Chamber of Commerce warned in its amicus brief in the Toshiba case that unless the justices stepped in to clarify that foreign companies aren’t liable for U.S.-traded securities they had no hand in creating or issuing, the trillion-dollar derivatives market could fall under siege.
The Supreme Court nevertheless declined to grant review of the Toshiba case last June, perhaps heeding the advice of the U.S. Solicitor General, who filed a brief opposing review. The Justice Department told the Supreme Court not to rush into the ADR issue. The 9th Circuit's ruling, the SG said, merely allowed ADR holders to take another crack at drafting a complaint against Toshiba – and even the 9th Circuit agreed that the investors' previous complaint didn’t pass muster. The Justice Department urged the Supreme Court to wait and see what happened after the case was remanded to the trial court.
We now know that outcome. And it’s bad news for Toshiba and other companies whose shares underlie unsponsored ADRs.
On Tuesday, U.S. District Judge Dean Pregerson of Los Angeles denied Toshiba’s motion to dismiss ADR investors’ amended complaint alleging accounting fraud. Applying the test mandated by the 9th Circuit, the judge held that the key question was whether ADR investors could show that the transactions in which they incurred “irrevocable liability” to pay for the ADRs took place in the U.S. The ADR holders' new complaint, Judge Pregerson said, alleged that the named investors placed buy orders, paid for and received title to their ADRs within U.S. territorial bounds. The transactions, he held, were therefore domestic.
Toshiba had argued that because the ADRs reference Toshiba common shares, ADR investors should be considered to have first purchased the underlying foreign-traded shares. The subsequent “conversion” of ownership of the Toshiba shares to ownership of unsponsored ADRs, Toshiba said, does not qualify as a purchase and cannot justify a securities class action in U.S. courts. Judge Pregerson said the company’s depiction of the ADR process would require him to disregard the complaint’s allegations of the nature of the transaction. At this preliminary stage of the case, the judge said, he can’t do that, although he left open the possibility that Toshiba can reassert its argument on summary judgment, if discovery bears out the company’s theory that the ADR investment originated as a purchase of common stock in a foreign transaction.
Toshiba also argued that the company can’t be liable because the company had no involvement in the sale of unsponsored ADRs, regardless of where the ADR transactions took place. The 9th Circuit ruling that led to the remand to Judge Pregerson held that in order to plead securities fraud, investors must allege that the defendant acted to induce them to buy the security. Toshiba said in its dismissal motion that ADR holders failed to allege that the company even consented to the sale of ADRs referencing its common stock. The company, argued Toshiba lawyers at White & Case, can’t be held responsible for trading in securities whose very creation was beyond its control.
Judge Pregerson rejected that reasoning as well. The ADR investors’ lawyers at Robbins Geller Rudman & Dowd, he said, plausibly alleged that Toshiba did consent to the sale of the securities. In particular, the judge noted that Bank of New York Mellon, which was a depository bank for Toshiba stock underlying ADRs, held about 55 million shares and was one of Toshiba’s ten biggest shareholders. Judge Pregerson quoted investors’ assertion that it seems unlikely that BNYM could have acquired such a significant stake without Toshiba’s “consent, assistance or cooperation.”
The judge even allowed ADR investors to revive their claims under Japanese securities law, holding that because the plaintiffs are U.S. nationals, the U.S. interest in enforcement outweighs comity concerns.
Toshiba counsel Christopher Curran of White & Case declined to comment. Robbins Geller’s Willow Radcliffe said the firm is pleased with the ruling. “This order allows Toshiba investors to now move this case forward and obtain redress for Toshiba’s fraudulent manipulation of its financial results.”
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