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Unsponsored ADR Programs and 10b Liability: The Creeping Territorial Scope of US Securities Laws to Non-US Issuers With Unsponsored ADR Programs

Stoyas v. Toshiba Corp., 424 F. Supp. 3d 821

On January 28, 2020, the United States District Court for the Central District of California (the District Court) denied Toshiba Corporation’s (Toshiba) motion to dismiss a putative class action complaint alleging securities fraud claims based on the purchase and sale of unsponsored American Depository Receipts (ADRs).  The District Court held that the Plaintiff had alleged adequately that Toshiba “plausibly” participated in the establishment of an unsponsored ADR program, and that therefore Toshiba could potentially face liability for alleged fraud “in connection with” Plaintiff’s purchase of the Toshiba ADRs.  The District Court also held that, at the pleading stage, the Plaintiff had sufficiently alleged a “domestic transaction” where the alleged purchase instruction, buy order, trade routing, issuance of, and payment for the ADRs all allegedly took place in New York.

This latest decision in the Toshiba saga, about which we have previously written, is likely to engender still more securities litigation in the Ninth Circuit, and particularly in California, based on transactions in unsponsored ADR programs.  Because unsponsored ADR programs can be established without an issuer’s involvement, or even knowledge, non-US public entities should take care to monitor whether an unsponsored ADR program for their securities has been created and take risk mitigating steps, as appropriate.

Background and Ninth Circuit Ruling

Toshiba is established under Japanese law and headquartered in Tokyo.  Its common stock trades on the Tokyo and Nagoya stock exchanges.  In September 2015, Toshiba revised its pre-tax profits downwards for fiscal years 2008 to 2014 by a total of US$2.6 billion.  The restated profits were the result of Toshiba’s admission of “widespread, deliberately fraudulent accounting practices” that ultimately caused a loss of approximately US$7.6 billion in Toshiba’s market capitalization.[1]

Plaintiff filed a lawsuit against Toshiba in 2015 in the District Court on behalf of, inter alia, a putative class of purchasers of Toshiba’s unsponsored, over-the-counter ADRs.  Plaintiff alleged that Toshiba committed securities fraud in violation of Section 10(b) of the Exchange Act, which prohibits fraudulent practices “in connection with the purchase or sale of securities,” including ADRs.

ADRs are negotiable certificates that represent a beneficial interest in (but not legal title to) certain shares of a non-US company.[2] As was the case for the Toshiba ADRs, they are most often issued by US banks who have title to the underlying shares of the non-US company.  ADRs can be either “sponsored” or “unsponsored.”  ADRs are “sponsored” when the non-US company enters into an agreement with the US depository institution for the bank to perform administrative and custodial services for the ADR holders.  The issuing bank and the non-US company jointly register sponsored ADRs with the US Securities and Exchange Commission (the SEC), after which the ADRs can be listed on major US stock exchanges.  Toshiba’s ADRs, however, are unsponsored: Toshiba had no formal involvement with their issuance by US banks, or with the registration of its ADRs with the SEC.  Because unsponsored ADRs cannot trade on US national exchanges, Toshiba’s ADRs were sold on an “over-the-counter” market allegedly located in New York and operated by OTC Link, which was allegedly based in New York.[3]

A threshold question in determining the viability of the lawsuit against Toshiba was whether Plaintiff alleged a transaction within the territorial scope of the Exchange Act.  Pursuant to the US Supreme Court’s decision in Morrison v. National Australia Bank, Ltd.,[4] Section 10(b) of the Exchange Act applies only to (1) transactions in securities listed on domestic exchanges, and (2) domestic transactions in other securities.[5]

Applying Morrison, the District Court initially concluded on May 26, 2016 that Plaintiff had not sufficiently alleged that it purchased its Toshiba ADRs in a domestic transaction, and that therefore its purchases fell outside the territorial scope of Section 10(b).  The District Court also found that amending the complaint would be futile, and therefore dismissed Plaintiff’s lawsuit with prejudice.

On July 17, 2018, the United States Court of Appeal for the Ninth Circuit (the Ninth Circuit) reversed the District Court’s decision.  Although the Ninth Circuit agreed that Plaintiff had not sufficiently alleged a “domestic transaction” nor sufficiently alleged that the fraudulent conduct was “in connection with” the sale or purchase of Toshiba’s ADRs, the Ninth Circuit held the District Court should have granted Plaintiff leave to fix these inadequacies.  The Ninth Circuit held that a securities transaction is “domestic”—and therefore within the territorial scope of the Exchange Act—if “the purchaser incurred irrevocable liability within the United States to take and pay for a security,” or “the seller incurred irrevocable liability within the United States to deliver a security.”[6] In the Ninth Circuit’s view, Plaintiff could “almost certainly” allege that it purchased Toshiba’s ADRs in a domestic transaction, given that Plaintiff alleged that (i) it purchased ADRs in the United States from a US bank, (ii) its own headquarters and operations were within the United States, and (iii) the over-the-counter trading system on which Plaintiff bought its ADRs was operated in the United States.

In coming to this determination, the Ninth Circuit considered and rejected a decision of the United States Court of Appeals for the Second Circuit (the Second Circuit), which held that, when securities are not listed on a US exchange, a domestic transaction is necessary but not necessarily sufficient to bring the transaction within the territorial scope of Section 10(b) when the claim otherwise is “predominantly foreign.”[7]  Similarly, the Ninth Circuit rejected Toshiba’s arguments that the unilateral activity of the US bank and the ADR purchasers should not suffice to pull the non-US activity of a non-US issuer within the territorial scope of the Exchange Act’s antifraud provisions.[8]

The Ninth Circuit did find, however, that Toshiba’s involvement in the US ADR program, or lack thereof, was relevant to whether Plaintiff stated a claim on the merits of Section 10(b).  In particular, the complaint did not sufficiently allege facts to show that the fraudulent conduct was made “in connection with the purchase or sale”[9] of the ADRs:  the complaint lacked factual allegations concerning, among other things, “the over-the-counter market on which [the] Toshiba ADRs are listed, whether Toshiba ADRs are sponsored, the depositary institutions that offer Toshiba ADRs, the [forms] used to register the Toshiba ADRs, the trading volume of Toshiba ADRs, and the Toshiba ADRs’ contractual terms.”[10]

The District Court’s Recent Decision

After the US Supreme Court denied Toshiba’s request to appeal the Ninth Circuit’s decision,[11] the case was remanded to the District Court and Plaintiff filed a second amended complaint (the SAC).  The SAC added allegations about the ADRs and Plaintiff’s purchase thereof.  Toshiba again moved to dismiss for failure to allege a “domestic transaction” and for failure to allege that Toshiba’s fraud was “in connection with” the purchase or sale of Toshiba’s ADRs.  The District Court denied Toshiba’s motion.

In deciding that Plaintiff sufficiently alleged a domestic transaction, the District Court explained that allegations concerning the place of “contract formation, placement of purchase orders, passing of title and the exchange of money” can be used to determine where a purchaser of a security incurred “irrevocable liability” to take and pay for that security.[12] Plaintiff alleged that its purchase order was directed by an investment manager in New York, that a broker in New York routed the purchase order to an over-the-counter trading platform located in New York, that the depository bank (Citibank) issued the ADRs from its offices in New York, that Plaintiff made payment from a New York bank, and a transfer of title was recorded in New York.[13] The District Court determined that these allegations, if true, would demonstrate that Plaintiff incurred irrevocable liability in the United States.[14]

In denying Toshiba’s dismissal motion, the District Court rejected Toshiba’s argument that because the ADRs were “issued” by Citibank, they necessarily required Plaintiff (or its agent) to first purchase Toshiba shares on a non-US exchange before creating ADRs.  Acknowledging the potential merit of Toshiba’s argument, the District Court nevertheless rejected the argument “[a]t the pleading stage,” explaining that to do otherwise would require the District Court to “disregard” Plaintiffs’ allegations, which the District Court was required to accept as true in evaluating a motion to dismiss.[15] The District Court stated, however, that if discovery revealed that Plaintiff’s ADR transactions involved an initial purchase of common stock in a non-US jurisdiction, then this issue would be “properly raised at the summary judgment stage.”[16]

In addition, the District Court held that Plaintiff properly alleged that its purchase of ADRs was made “in connection with” Toshiba’s alleged fraud.  Plaintiff alleged that Bank of New York Mellon—a depository institution for Toshiba’s ADRs—held 1.3%, or approximately 55 million shares of Toshiba’s outstanding common stock, and it is “unlikely that that many shares could have been acquired on the open market without the consent, assistance or participation of Toshiba.”[17] The District Court found that this allegation “sufficiently alleged Toshiba’s plausible participation in the establishment of the ADR Program.”[18]

Finally, the District Court rejected Toshiba’s argument that considerations of international comity should compel dismissal of Plaintiff’s lawsuit.  The District Court reasoned that such concerns “are addressed, and lessened when a plaintiff has sufficiently alleged conduct in connection with a domestic transaction.”[19] The District Court accepted that the Ninth Circuit’s test for what constitutes a domestic transaction “may very well” result “in the Exchange Act’s application to claims of manipulation of share value from afar.”[20]

Implications for Non-US Issuers

The Ninth Circuit’s decision implied, and the District Court’s subsequent decision confirmed, that US investors’ unilateral transactions in a non-US issuer’s unsponsored ADRs may, at least under certain circumstances, constitute a “domestic transaction” within the territorial scope of the Exchange Act.  And, although the Ninth Circuit suggested that the non-US issuer would need to have some involvement with the establishment of its US ADR program to satisfy the “in connection with” requirement of the Exchange Act’s antifraud provisions, the District Court’s decision demonstrates just how little involvement is required to survive a dismissal motion. Indeed, under the District Court’s analysis, the fact that a US depository institution held just 1.3% of Toshiba’s common stock was enough to allow for a plausible inference that Toshiba participated in establishing its unsponsored ADR program.[21] While Toshiba will be able to challenge this holding after discovery at summary judgment, the District Court’s decision certainly increases risks to non-US issuers, whose unsponsored ADRs are traded in the United States.

This could come as an unwelcome development to non-US companies with unsponsored ADR programs because the rulings of the Ninth Circuit and District Court may make it more difficult to dispose of a securities class action at the early stages of a lawsuit.  The risk is further heightened because the District Court’s ruling has effectively provided—at least until these issues are relitigated at summary judgment—a roadmap for other plaintiffs to follow in future cases.

Of course, a non-US company’s lack of contacts with the US may give rise to jurisdictional defenses.  If a non-US issuer with securities traded on non-US exchanges takes no action in the US in furtherance of its ADR program or the alleged fraud, then it may be difficult for US investor plaintiffs to demonstrate, as they must, that a US court has jurisdiction over the non-US issuer.

Finally, the US Supreme Court declined to review the Ninth Circuit’s ruling.  Therefore, at least for the near-term, a difference will remain amongst courts in the Second and Ninth Circuits over the extent to which the unilateral activity of third parties within the United States can create a “domestic transaction” within the scope of the Exchange Act.  In the Second Circuit, the Exchange Act does not reach “predominantly foreign” securities fraud claims, even if irrevocable liability occurs within the United States.  In the Ninth Circuit, it does.  Thus, foreign issuers should be wary that they may be called to US federal court if their stocks are traded as ADRs in an over-the-counter market transaction, especially those transactions over which the Ninth Circuit has jurisdiction.

Can Non-US Companies With Unsponsored ADR Programs Mitigate Their Exposure?

Most unsponsored ADR programs comprise a relatively small percentage of a company’s share capital, and recent direct sales of ordinary shares by an issuer and its affiliates pursuant to Rule 144A or another exemption from SEC registration are a more straightforward path to Rule 10b-5 liability exposure for the typical non-US issuer, both in the legal analysis and by quantum of exposure.

However, if, on balance, a non-US issuer decides that its potentially increased risk of Section 10(b) liability exposure outweighs the liquidity and investor relations benefits of unsponsored ADR programs, it could consider one or more of the following steps to mitigate (but, particularly in the Ninth Circuit, probably not eliminate) the risk:

  • If approached by a depositary bank wanting to establish an unsponsored program, issuers should not give any consent requested by the bank.
  • Issuers can give notice on their Investor Relations website that they are not involved in or responsible for any unsponsored ADR programs in their shares (where this is, in fact, the case).
  • If issuers have already given such consent, they could consider withdrawing their consent.
  • If issuers have not given such consent, they could consider so notifying the depository institution.

Please do not hesitate to reach out to your usual Freshfields contacts if you have any questions.

[1] See Toshiba v. Stoyas, 424 F. Supp. 3d 821, 824 (C.D. Cal. 2020).

[2]See Toshiba v. Stoyas, 896 F.3d 933, 940 (9th Cir. 2018).

[3] Toshiba, 424 F. Supp. 3d at 826.

[4] 561 U.S. 247 (2010).

[5] Id. at 267.

[6] Toshiba, 896 F.3d at 948.

[7] See Parkcentral Global Hub v. Porsche Automobile Holdings, S.E., 763 F.3d 198 (2d Cir. 2014).

[8] Toshiba, 896 F.3d at 950.  Even though the Ninth Circuit rejected the Second Circuit’s decision in Parkcentral, the Parkcentral decision remains binding upon district courts within the Second Circuit and may be persuasive to US district courts outside the Ninth Circuit.

[9]             Id. at 951.


[11]            Toshiba Corp. v. Auto Indus. Pension Trust Fund, 139 S. Ct. 2766 (June 24, 2019).

[12] Toshiba, 424 F. Supp. 3d at 825.

[13] Id. at 826.

[14] Id.

[15] Id. at 826-27.

[16] In contrast to a motion to dismiss, which tests only the sufficiency of a plaintiff’s allegations, a motion for summary judgment tests the sufficiency of admissible evidence, and whether there is sufficient evidence for a reasonable fact-finder to decide the case in favor of the plaintiff.

[17]Toshiba, 424 F. Supp. 3d at 828.

[18]Id.  Plaintiff also alleged that Toshiba published its quarterly and annual results and regulatory filings in English, as is necessary for US depository institutions to sell Toshiba’s ADRs in the United States, and that such English-language publication supported the inference that Toshiba “consented to and participated in the sale” of its ADRs.  See SAC ¶ 74.  Although the District Court’s decision is silent on the matter, the Ninth Circuit previously suggested that such allegations could suggest that Toshiba “was indeed involved” in the establishment of its ADRs.  See Toshiba, 896 F.3d at 951-52.

[19]Toshiba,424 F. Supp.3dat 829.


[21] Plaintiff also alleged in the SAC that it is common practice for US depository institutions to seek the consent of non-US issuers before establishing an unsponsored ADR Program in their shares, and that US depository institutions do not ordinarily establish unsponsored ADR programs without such consent.  Therefore, Plaintiff argued that the existence of the US ADR program in Toshiba’s common stock was evidence that Toshiba either affirmatively or impliedly consented to establishment of its ADRs.  See SAC at ¶¶ 69-70.  The District Court’s decision does not reveal whether it found such allegations persuasive.


Linda Martin

Doug Smith

David Livshiz

Henry Hutten
Senior Associate