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Freshfields Transactions

| 5 minutes read

Unsponsored ADR programmes and Rule 10b-5 (again and it’s not over yet)

In a positive development for non-US issuers, a new ruling in the long-running Stoyas v Toshiba case offers possible additional defence strategies against US securities fraud class actions involving unsponsored American Depositary Receipt (ADR) programmes - but such issuers should still be aware of continued liability exposure.

What has happened

In the latest ruling in January 2022, a federal district court in California declined to certify a proposed class of international investors in Toshiba, finding that the lead plaintiff failed to meet the requirement that their claim be typical of the claims of the plaintiffs they represent in that their purchase of unsponsored Toshiba ADRs had initially been made as a purchase of common stock outside the US and was therefore outside the territorial scope of the US federal securities laws (including Rule 10b-5). Without class certification, the US securities fraud claims asserted on behalf of Toshiba’s unsponsored ADRs could end or be settled on terms more favourable to Toshiba. However, the plaintiffs have appealed this latest ruling, so the case is not over yet.

While this development may render such securities fraud class actions claims somewhat more uncertain and therefore less attractive for plaintiffs to bring, non-US issuers remain vulnerable to such claims so should still be aware of their liability exposure when they find their common stock is subject to an unsponsored ADR programme. See the last section below for ways issuers can mitigate the risks associated with unsponsored ADR programmes.

Case history

To recap, in 2018, we alerted you to this unwelcome case in the US federal appeals court for the Ninth Circuit (Stoyas v Toshiba Corp, 896 F.3d 933 (9th Cir. 2018)) which opened the door to increased securities fraud claims against non-US companies with unsponsored ADR programmes. The case also gave rise to a so-called circuit split with the Second Circuit which has taken a less plaintiff-friendly approach (which remains unresolved). The split centres on the interpretation of “domestic transaction” in the US Supreme Court case of Morrison v National Australia Bank 561 US 247 (2010). In Morrison, the Supreme Court decided that section 10(b) of the Securities Exchange Act of 1934 does not apply extraterritorially, ie to securities transactions outside the US, but only to 1) transactions in securities listed on US domestic exchanges and 2) domestic transactions in other securities.

Toshiba is a Japanese company, headquartered in Tokyo. Its ADRs are not sponsored by the company (ie the company is not a party to the constitutive documents) and trade over the counter (OTC) in the US (ie are not listed on a US exchange). Toshiba’s common stock is listed only in Tokyo and Nagoya. The lead plaintiff, representing a class of purchasers of Toshiba’s ADRs, alleged that they purchased their ADRs in reliance on the accuracy of Toshiba’s financial statements and were damaged when accounting fraud at Toshiba was revealed in 2015. 

Despite initial success for Toshiba at district court, on appeal in 2018, the Ninth Circuit found for the plaintiffs on the ground that all that is required for there to be a domestic transaction under Morrison is that one party must have incurred “irrevocable liability” to take and pay for the securities in the US (irrespective of whether Toshiba was involved).

The case was remanded to the federal district court (Stoyas v Toshiba Corp, 424 F.Supp.3d 821 (CD Cal 2020)) which denied Toshiba’s motion to dismiss (a motion which requires the court to accept the plaintiff’s allegations as true), in part on the basis that the lead plaintiff’s allegation, that the shares underlying the ADR programme were unlikely to have been acquired without the consent or other involvement of Toshiba, sufficiently alleged Toshiba’s plausible participation in establishing the ADR programme. The plaintiff’s allegation was based on the fact that the shares held through the ADR programme constituted 1.3% of Toshiba’s outstanding common stock.

In February 2021, after 13 months of discovery, the lead plaintiff moved to certify a class of plaintiffs who were purchasers of Toshiba’s unsponsored ADRs “using the facilities of the OTC Market”. As noted above, in January 2022, that court made the latest ruling, declining to certify the class (Stoyas v Toshiba Corp, No. 2:15-cv-04194 DDP-JC, 2022 WL 80469 (CD Cal Jan 7, 2022)).

ADR programmes

As a reminder, unsponsored ADR programmes are set up, generally without the company’s formal involvement, by financial institutions which want to establish a US over-the-counter market in the ADRs. ADRs are negotiable certificates that represent a beneficial interest in (but not legal title to) certain shares in a non-US company. Usually, and as was true for the Toshiba ADRs, the ADRs are issued by US depositary banks which have acquired the underlying shares of the non-US company before issuing the ADRs representing such shares. By contrast, sponsored ADR programmes involve the non-US company having an agreement with a US depositary bank to establish the programme and the non-US company is a party to the deposit agreement. The bank issuing the ADRs, and the non-US company then jointly register the sponsored ADRs with the US Securities and Exchange Commission (SEC) on Form F-6.

Basis for 2022 ruling and implications for non-US issuers

There is a recent trend for companies defending US securities fraud class action lawsuits to end or limit these actions by defeating class certification. In line with this trend, the 2022 ruling could provide a new argument that companies with unsponsored ADR programmes can raise when opposing class certification. The key issue is the location where irrevocable liability was incurred when the investor purchased the ADRs. If that location is outside the US, defendants may have a new strategy to follow at the class certification stage. Toshiba established that the plaintiff’s financial intermediaries initially acquired its securities as shares of common stock traded on the Tokyo Stock Exchange, before those shares were deposited into the ADR programme (not uncommon when an investor wants a significant number of ADRs). As a result, the plaintiff incurred irrevocable liability to take and pay for the securities in Japan and therefore did not undertake a “domestic transaction” within the Morrison test and the transaction was not within the scope of Rule 10b-5. While not every ADR purchaser may fall into this fact pattern, the 2022 ruling muddies the waters for plaintiffs on class certification, making progress through the litigation process less certain.

For more on the 2022 ruling and its implications as well as the case history, please see the recent blog from our US-based litigators: US securities fraud liability for non-US issuers of securities subject to unsponsored ADRs: New ruling opens up additional defense strategies

Mitigating the risks of unsponsored ADR programmes

Most unsponsored ADR programmes 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 (including as part of the company’s initial public offering in its home market) 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 programmes, 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 programme, 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 programmes 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 bank.

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


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