Ever since the Supreme Court issued its opinion in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010), courts have been making their own interpretations of what Morrison means for whether certain transactions are “domestic” and thus amenable to class-action securities claims.  Judge Dean Pregerson of the U.S. District Court for the Central District of California recently weighed in with a May 20, 2016 opinion (“Op.”) dismissing all claims with prejudice in the Stoyas et al. v. Toshiba Corporation class action, No. CV 15-04194, for failure to allege that the alleged fraud involved domestic transactions.  Although the opinion considers certain Japanese-law claims, the key question the Court addresses is whether Morrison allows claims to be brought based on transactions in unsponsored American Depositary Shares for non-U.S. companies.

As background, the plaintiffs in the Toshiba action alleged that Toshiba (i.e., “Defendant”) “and two of its former Chief Executive Officers had violated U.S. securities laws by selling stock with an inflated price caused by Defendant’s false profit reports.”  (Op. at 2.)  “According to Plaintiffs, this case arises from Toshiba’s deliberate use of improper accounting over a period of at least six years to inflate its pre-tax profits by more than $2.6 billion and conceal at least $1.3 billion in impairment losses at its U.S. nuclear business, Westinghouse Electric Co.”  (Id. at 3-4 (internal citations omitted).)  Plaintiffs’ First Amended Complaint emphasizes the U.S. connection to Toshiba’s public communications, including “both English- and Japanese-language corporate websites at http://www.toshiba.co.jp, on which it established an Investor Relations section where regulatory filings, press releases, conference call transcripts, corporate profiles, descriptions of its business, and other information about the Company is made available to investors,” and “annual reports [which] included detailed financial information presenting results in both Japanese and U.S. currency.”  (First Amended Complaint (“Compl.”) at ¶ 28.)

Plaintiffs made claims under not just “sections 10(b) and 20(a) of the Securities Exchange Act of 1934 … and SEC rule 10b-5,” but also under “Japan’s Financial Instruments & Exchange Act (‘JFIEA’) … over which they argue the Court has diversity and supplemental jurisdiction.”  (Id. at 3, 5.)  Plaintiffs’ proposed class is defined as:

1. all persons who acquired Toshiba American Depositary Shares or Receipts (“ADSs”) between May 8, 2012 and November 12, 2015 (the proposed class period) and

2. all citizens and residents of the United States who otherwise acquired shares of Toshiba common stock.

(Op. at 3).  An ADS is an equity share of a non-U.S. company that trades in the U.S. financial markets in U.S. dollars, thus simplifying the process through which American investors can trade in foreign companies.  Although foreign companies can sponsor the trading of their ADSs, many ADSs are unsponsored and sold on the over-the-counter market without any formal agreement between the issuer and a depositary bank.  SEC Rule 12g3-2 allows “foreign unsponsored ADS sales if ‘the issuer maintains its listing on a foreign exchange and complies with the requirements to provide American investors with electronic access to English-language translations of the information provided to their foreign-investors.’”  (Id. at 20 (quoting SEC Rule 12g3-2).)  Plaintiffs’ First Amended Complaint notes that Toshiba posted on its website “English-language versions of its annual and quarterly reports, earnings and other press releases, investor presentations, governance and business policies, and other information reflecting the Company’s results of operations or financial condition, changes in business, acquisitions or dispositions of assets, changes in management or control, and other information required to maintain compliance with SEC Rule 12g3-2.”  (Compl. at ¶ 29.)

Toshiba’s motion to dismiss made two primary arguments: “(1) there are no facts pled — or that could be pled — to support a U.S. Securities Exchange Act cause of action by Plaintiffs, or any other potential class member, because there are no securities sold or listed in the United States by Toshiba Corporation; and (2) the Japanese law claim should be dismissed under principles of comity and forum non conveniens.”  (Op. at 9.)  For the first issue, Toshiba “relies fundamentally on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010). Defendant claims that Morrison established that the U.S. Securities Exchange Act does not apply to securities-fraud claims against a foreign issuer that did not list its securities on a U.S. exchange or otherwise trade its securities in the United States. … Here, Defendants argue, Toshiba is a foreign issuer and does not list its securities on a U.S. exchange — only in Tokyo and Nagoya, according to Defendant — and Toshiba does not otherwise trade securities, including ADSs, in the United States.”  (Id. at 11 (internal citations omitted).)  “According to Defendant, … Plaintiffs cannot state a claim because Toshiba” fulfills neither of the two prongs under Morrison for considering a transaction to be domestic, namely that Toshiba “neither (1) lists its stocks on a U.S. exchange nor (2) sells any other security in the United States.”  (Id. at 13.)  “Defendant claims that OTC markets — where Plaintiffs here bought the … ADSs — are not national stock exchanges under the first prong of the rule in Morrison.”  (Id. at 14.)

In response, “Plaintiffs disagree with this distinction between national security exchanges and OTC markets.”  (Id. at 14.)  “Plaintiffs claim that Morrison drew a distinction between foreign exchanges and domestic exchanges, not domestic stock exchanges and domestic over-the-counter markets.”  (Id. at 14.)

The Court looked to the legislative history of Section 10(b) of the Securities Exchange Act in making its decision, noting that “[t]he statute’s statement of purpose explicitly references over-the-counter markets as well as securities exchanges, stating that both are effected with a national public interest which makes it necessary to provide for regulation and control of such transactions and of practices and matters related thereto.” (Id. at 15 (internal quotations omitted).)  Because “[t]he statute thus recognizes a distinction between securities exchanges and OTC markets,” and “Plaintiffs have not pled or argued that the OTC market at issue here satisfies the requirements to be an ‘exchange,’” the Court held “that the OTC market in this case is not a domestic exchange satisfying the first prong of Morrison.”  (Id. at 16-17.)

Looking to the second, alternative prong of the Morrison test, namely whether the claim concerns “purchases or sales of securities in the United States,” Toshiba argued that “any domestic transaction alleged by Plaintiffs was not done by Toshiba and did not involve Toshiba.”  (Id. at 17.)  Instead, Toshiba argued, “the underlying Toshiba common stock was purchased by the depositary bank on a foreign exchange (a foreign transaction), and the depositary bank then sold ADSs based on those common stocks to Plaintiffs in the United States. Thus, the domestic transaction was between depositary banks and ADS purchasers, not between Defendant and ADS purchasers.”  (Id. at 17.)  Toshiba argued that “the ADSs here are unsponsored and set up without the cooperation of Toshiba and that ADR holders have no direct relationship with, and no ownership in, Toshiba.” (Id. at 17 (internal citations omitted).)

In contrast, Plaintiffs contested Toshiba’s understanding of how Morrison applied to ADSs.  “First, Plaintiffs argue that the [Supreme] Court in Morrison was expressly carving out sales and purchases of ADSs in the United States from its holding.  According to Plaintiffs, the Court in Morrison contemplated that domestic transactions subject to U.S. securities laws included domestic sales and purchases of ADSs, even those not listed on a national security exchange but instead on some kind of domestic exchange or OTC market. … And Plaintiffs argue that even if the OTC market is not considered a domestic exchange, the ADS purchases here are domestic transactions under the second prong of Morrison because the purchases and sales all took place in the United States where the OTC market is located.” (Id. at 19 (internal citations omitted.)  Plaintiffs also argued that this discussion was procedurally premature.  “Plaintiffs state that the status of an ADS as sponsored or unsponsored does not matter for determining the applicability of § 10(b),” because “Toshiba’s claim about the ADSs here being unsponsored raises factual issues not appropriate for a motion to dismiss regarding Toshiba’s involvement in the ADSs’ sale.” (Id. at 19-20.)  “Additionally, all ADSs, whether sponsored or not, are held by a depositary bank, which ultimately holds the underlying security and sells the ADS.” (Id. at 20.)  “Lastly, Plaintiffs argue that the unsponsored nature of the ADSs is irrelevant for the purposes of Morrison, particularly as the difference between a sponsored and unsponsored ADS is somewhat artificial. … To Plaintiffs, the only difference between the sponsored and unsponsored ADSs … is that an unsponsored ADS can be sold without a formal application by the foreign issuer to establish a ADS program; the disclosure requirements are otherwise the same.” (Id. at 20-21.)   Plaintiffs also included a policy argument for allowing the case to proceed: “Plaintiffs argue that finding that Toshiba is subject to the U.S. securities laws through the ADS sales in the United States would prevent Toshiba from evading liability by refusing to memorialize its consent to the sale of ADSs.”  (Id. at 21 (internal citations omitted).)

As with the first prong of the Morrison test, here the Court sided with Toshiba.  According to the Court, “Plaintiffs have not argued or pled that Defendant was involved in those transactions in any way — or pointed to how discovery could assist Plaintiffs in making such a claim.”  (Id. at 23.)  In addition, although “privity or some other kind of direct transactional relationship is not required between a plaintiff and a defendant in a § 10(b) case,” the Court held that “nowhere in Morrison did the Court state that U.S. securities laws could be applied to a foreign company that only listed its securities on foreign exchanges but whose stocks are purchased by an American depositary bank on a foreign exchange and then resold as a different kind of security (an ADR) in the United States.”  (Id. at 23-24.)  “Most importantly, Plaintiffs have not alleged or provided any evidence (or pointed to where Plaintiffs reasonably expect to find evidence) of any affirmative act by Toshiba related to the purchase and sale of securities in the United States. Some affirmative act in relation to the purchase or sale of securities is required under the Supreme Court’s holding” in Morrison.  (Id. at 24.)  The Court acknowledged that “[t]here are allegations that Toshiba committed accounting fraud and misrepresented its profits to investors around the world.”  (Id. at 25.)  However, “there is no allegation that those fraudulent actions were connected to Toshiba selling its securities in the United States.”  (Id. at 25.)  As a result, the Court dismissed with prejudice all of Plaintiffs’ claims under the Exchange Act and Rule 10b-5.

The Court also dismissed Plaintiffs’ Japanese law claim due to comity concerns and on forum non conveniens grounds.  After weighing the various factors required in the Ninth Circuit, the Court held “that the comity issues raised in this case weigh in favor of dismissal … due to the cause of action being based on Japanese securities law for actions of a Japanese company that only lists its securities in Japan (which is also where the fraudulent accounting primarily took place).”  (Id. at 30.)  “Plaintiffs’ concern that ADS purchasers — who Plaintiffs earlier argued engaged in domestic (U.S.) transactions — will not be able to sue in Japan under Japanese securities laws is perhaps based on the proper application of the Japanese securities laws, not an indication that this Court should keep this cause of action.”  (Id. at 30.)  As to the forum non conveniens issue, the Court held, “as an alternative” to its holding on comity, that “the doctrine of forum non conveniens makes dismissal proper for the Japanese law cause of action. … There are many practical issues with fully litigating this cause of action in this Court, particularly with taking discovery from and deposing non-Toshiba employees that Plaintiffs have identified as key witnesses and perpetrators of the accounting fraud,” as “most of the evidence and witnesses identified by both parties as material are in Japan, and Japan has the strongest factual connection to the Japanese law claim.”  (Id. at 34-35.)  Although “[t]he Court recognizes its duty to hear cases over which it has jurisdiction, but the Court also finds that Japanese courts are more than competent to hear these claims.”  (Id. at 35.)

While the Court holds that an issuer of an unsponsored ADR could be seen as not having transacted business within the United States, it is also true that the issuer benefited from access to American investors nonetheless, even if the transactions took place on an over-the-counter market and not on a national securities exchange.  Thus, the end result, where U.S.-based investors are denied recourse in U.S. courts regarding securities purchased within the United States, even after Toshiba appears to have gone out of its way to post English-language financial information on its website and comply with unsponsored ADS requirements under U.S. law, may surprise many observers.