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ADR case will test reach of investors on overseas firms

David Kistenbroker said ADRs give investors a ‘hook’ into foreign firms.

Institutional investors in the U.S. may have lost their ability to sue foreign stock issuers in U.S. courts after a pivotal 2010 Supreme Court decision, but they are finding some success with American depository receipts, and a case now up for Supreme Court review could potentially expand their legal recovery options well beyond ADRs.

"ADRs give plaintiffs a hook in the U.S. Institutional investors seem to be pretty active in these cases," said David Kistenbroker, global co-leader of Dechert LLP's white collar and securities litigation practice in Chicago.

U.S. institutional investors pursued all types of investment litigation cases against foreign companies in U.S. courts until June 2010, when the U.S. Supreme Court ruled in Morrison vs. National Australia Bank that lawsuits against companies involving foreign-bought securities could not be brought in U.S. courts.

The Morrison decision might have had a chilling effect on lawsuits against non-U.S. issuers for a while, but they have increasingly become targets in securities class actions filed in the U.S., regardless of where the allegations occur, Mr. Kistenbroker said. His firm's analysis of cases filed in 2018 found 13% of securities fraud class actions were brought against non-U.S. issuers in 2018.

A Securities and Exchange Commission rule change in 2008 made "unsponsored" ADRs — opposed to ones sponsored by their overseas issuers that can trade on exchanges — highly attractive to major U.S. banks, which reported a 766% growth from 2008 through the third quarter of 2018, when $31 billion were traded.

More litigation

The growth in popularity of both kinds of ADRs has also brought more litigation by investors when things don't work out.

Just ask officials at Petroleo Brasileiro SA-Petrobras, which in January 2018 agreed to pay $2.95 billion to settle a class-action suit led by the 64 billion ($82.6 billion) Universities Superannuation Scheme, London, and joined by North Carolina's treasurer on behalf of the North Carolina Retirement Systems and the Hawaii Employees' Retirement System.

The largest U.S. class-action settlement in 2018 also gave Petrobras the dubious distinction of being the largest non-U.S. company ever to settle with shareholders that held the company's ADRs.

ADR investors led by the $1.4 billion Arkansas State Highway Employees' Retirement System, Little Rock, and the $1.6 billion Miami Police Relief and Pension Fund expected final approval May 10 of a $48 million settlement with Volkswagen AG over its emissions testing scandal. While the award pales in comparison to that of Petrobras, plaintiffs were pleased that the District Court judge rejected the company's central argument that the shares were beyond the territorial reach of U.S. securities law because of the Morrison decision.

Things got more interesting when the 9th U.S. Circuit Court of Appeals in San Francisco reinstated a case brought by purchasers of unsponsored Toshiba Corp. ADRs not related to the company but instead issued by banks and sold on over-the-counter markets. In its July 2018 order to reverse and remand the case led at this point by its plaintiffs, the $1.2 billion Automotive Industries Pension Trust Fund and the $2.9 billion New England Teamsters & Trucking Industry Pension Fund, the 9th Circuit said the ADR purchases met the conditions set by the Morrison decision, and that the Exchange Act could only apply to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities."

The Toshiba ADRs were purchased in the U.S. by U.S. investors from U.S. banks, making it a domestic transaction, the court said.

The case, Toshiba Corp. vs. Automotive Industries Pension Trust Fund, is now on hold, thanks to a perceived circuit split that led Toshiba to petition the Supreme Court for review.

Toshiba's argument

In its petition, Toshiba argued that the 9th Circuit rejected a 2014 ruling by the 2nd Circuit Court of Appeals in New York in Parkcentral Global Hub vs. Porsche Automobile Holdings that relied on Morrison to hold that a domestic transaction was not sufficient to have a domestic claim against foreign interests.

By departing from the Porsche ruling, Toshiba's lawyers argued, "the Ninth Circuit in effect has opened a new forum for U.S. class-action litigation against any foreign issuer in the world.

"Merely by transacting in a foreign issuer's securities (or a derivative thereof) in the U.S., third parties can manufacture rights under the Exchange Act not available to parties that transact in the same securities abroad," they argued.

The repercussion of letting the 9th Circuit prevail will go far beyond the $12 billion market in unsponsored ADRs and negatively impact the multitrillion-dollar derivatives market as well, warned the U.S. Chamber of Commerce's brief, while the Securities Industry and Financial Markets Association and its European counterparts, as well as officials from Japan and the U.K., warned that it would seriously harm worldwide securities markets and put the U.S. in direct conflict with foreign jurisdictions.

"The issuer community is really looking at the implications of the Toshiba case beyond just its impact on ADRs," said Daniel S. Sommers, partner with the Cohen Milstein Sellers & Toll PLLC law firm in Washington, who views the appellate ruling in Toshiba as legally sound and "fully faithful to the Supreme Court's bright line approach in Morrison."

He cautions that the high court might take a pass on the case in part because the 2nd Circuit's Porsche opinion upon which Toshiba relies "is extremely fact-bound" and specific to that case, he said.

If the Supreme Court hears the case and favors the 2nd Circuit's approach in Porsche, "there will be a much more narrow view of the kinds of securities cases that can take place here in the U.S.," Mr. Sommers said.