(Article from Securities Law Alert, January 2017)
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In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court held that Section 10(b) applies only to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.”[1]
On January 4, 2017, the Northern District of California held that purchases within the United States of American Depositary Receipts (“ADRs”) sponsored by a foreign issuer qualified as “domestic transactions in other securities” within the meaning of the second prong of the Morrison test. In re Volkswagen ‘Clean Diesel’ Marketing, Sales Practices, and Products Liability Litig., 2017 WL 66281 (N.D. Cal. 2017) (Breyer, J.). The court reasoned that Section 10(b) reached the purchases because the foreign issuer “sponsored the ADRs in the United States,” investors “purchased the ADRs here,” and “the United States has an interest in protecting domestic investors against securities fraud.”
The court also ruled that over-the-counter markets are not “domestic exchanges” for purposes of the first prong of the Morrison test.
Morrison Reaches Domestic Transactions in ADRs Sponsored by Foreign Issuers
At the outset of its analysis, the court explained that “ADRs may be either sponsored or unsponsored.” While an “unsponsored ADR is established with little or no involvement of the issuer of the underlying security,” a sponsored ADR “is established with the active participation of the issuer.” In the case before it, the court found the foreign issuer “sponsored the ADRs and thus was directly involved in the domestic offering of the ADRs.”
The court found it significant that the foreign issuer had taken “affirmative steps to make its securities available to investors . . . in the United States.” For example, the governing deposit agreements provided that New York law would apply to the ADRs. The foreign issuer also “provided on its website English versions of its public disclosures in compliance with United States regulations so that it could offer ADRs to investors in the United States.” The court held these actions “establish[ed] a sufficient connection between the [foreign issuer’s] ADRs and the United States” for purposes of the second prong of Morrison’s test.
United States Purchases of ADRs Sponsored by a Foreign Issuer Are Not “Predominantly Foreign” Transactions
Defendants attempted to rely on the Second Circuit’s decision in Parkcentral Global Hub v. Porsche Automobile Holdings, 763 F.3d 198 (2d Cir. 2014)[2] to argue that “even where a domestic transaction exists, Section 10(b) does not apply if the transaction is ‘predominantly foreign.’” In Parkcentral, the Second Circuit affirmed dismissal of Section 10(b) claims involving securities-based swap agreements that referenced a foreign issuer’s stock, where there were no allegations that the foreign issuer was a party to, or participated in any way, in the swap agreements at issue. The Second Circuit held that “the imposition of liability under § 10(b) on . . . foreign defendants with no alleged involvement in plaintiffs’ transactions, on the basis of the defendants’ largely foreign conduct, . . . would constitute an impermissibly extraterritorial extension of the statute.” 763 F.3d 198.
The Northern District of California found that “the unique circumstances of Parkcentral” were not present in the case before it. Volkswagen, 2017 WL 66281. Here, the foreign issuer’s actions were “clearly tied to the United States.” The court found “the ADRs [were] not independent from [the issuer’s] foreign securities or from [the issuer] itself.”
Over-the-Counter Markets Are Not “Domestic Exchanges” Under Morrison
The court further ruled that the over-the-counter market on which the ADRs traded did not constitute a “domestic exchange” within the meaning of the first prong of the Morrison test. The court reasoned that the statement of purpose of the Securities Exchange Act, 15 U.S.C. § 78b, “explicitly references over-the-counter [“OTC”] markets as well as securities exchanges,” and “thus recognizes a distinction between securities exchanges and OTC markets.”
[1] Please click here to read our discussion of the Morrison decision.
[2] Please click here to read our discussion of the Second Circuit’s decision in Parkcentral.