The Toshiba Securities Litigation stems from alleged violations of the Exchange Act, as well as the Financial Instruments and Exchange Act of Japan, against Toshiba Corp., in connection with its alleged accounting fraud and accompanying restatements of its financial reports. The plaintiffs represented a class of investors who had purchased Toshiba’s American Depository Shares or Receipts (ADRs) on the over-the-counter (“OTC”) market, rather than direct purchases of Toshiba common stock, which trade in Japan. ADRs are financial instruments, issued by U.S. depository banks, which enable investors in the United States to buy and sell stock in foreign corporations whose common stock is publicly traded on a foreign stock exchange, without having to actually buy and sell on that foreign exchange. They also give foreign companies easier access to U.S. capital markets.
The plaintiffs alleged that they paid artificially inflated prices for the ADRs as a result of Toshiba’s alleged fraud. The district court dismissed the case with prejudice, holding Morrsion precluded the plaintiffs from bringing claims for alleged losses on the ADRs because the OTC is not a “national exchange,” and that there was no transaction, in the United States, between the plaintiffs and Toshiba. The distinction between ADRs and common stock was critical to the district court’s dismissal of the Plaintiffs’ claims.
However, the U.S. Court of Appeals for the Ninth Circuit reversed and determined that the ADR trades were domestic. Toshiba argued that, under the U.S. Supreme Court’s decision in Morrison, its ADRs were not governed by Section 10(b) of the Exchange Act, because the Exchange Act applies only to transactions on a national securities exchange. The court disagreed. It held that the Exchange Act could apply to the Toshiba ADRs because, under Morrison, another category of transactions covered by the Exchange Act is “domestic transactions in other securities.” Acknowledging that Morrison said that the act exclusively focuses on “domestic purchases and sales,” the Ninth Circuit adopted other Circuits’ use of an “irrevocable liability” test to determine when a securities transaction is domestic. The irrevocable liability test looks to where purchasers incurred the liability to take and pay for securities, and where sellers incurred the liability to deliver securities, and not where the alleged misconduct occurred. Noting that the Plaintiffs’ ADRs were purchased in the United States, and that the depository institutions sold the ADRs in the United States, the court held that the Exchange Act could apply to the Toshiba ADRs. Thus, the Ninth Circuit held that purchases of Toshiba ADRs traded on the OTC satisfied Morrison’s requirements to be considered domestic transactions.