By: Wendy Giblin and Nathaniel Orenstein
One common way to diversify a portfolio with international investments is by investing in American Depository Receipts (“ADRs”). ADRs represent shares of stock issued by a foreign company without the underlying stock trading on an American exchange. Typically, ADRs are denominated in U.S. dollars and their inherent value tracks that of the underlying shares, which trade on a foreign exchange.
Since the U.S. Supreme Court issued its landmark ruling in Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010), there has been ambiguity as to whether ADR investors could sue in the U.S. for securities fraud. In Morrison, the Court had held that investors could not pursue claims under the federal securities laws unless the security was (1) listed on a domestic exchange or (2) the subject of a domestic transaction. Since then, there have been various legal battles as to whether federal securities fraud claims could be pursued for losses to over-the-counter purchases of unlisted ADRs.
One of the consequences of Morrison is that different types of ADRs are affected in different ways. ADRs that trade on U.S. exchanges are covered under the first prong of Morrison. This is exemplified by In re BP p.l.c. Sec. Litig., in which defendants successfully raised a Morrison defense in their effort to dismiss claims by purchasers of B.P.’s common stock on the London Stock Exchange, but did not even bother to assert a Morrison defense in connection with B.P.’s ADRs listed on U.S. exchanges. 843 F. Supp. 2d 712, 794 (S.D. Tex. 2012)
The fate of unlisted ADRs is far murkier. In an early post-Morrison decision involving the ADRs of French company Société Générale, plaintiffs included investors who acquired their ADRs in the U.S. over-the-counter market. The court dismissed their claims, holding broadly that “[t]rade in ADRs is considered ‘predominantly foreign securities transaction'” making Section 10(b) inapplicable. In re Société Générale Sec. Litig., No. 08 Civ. 2495(RMB), 2010 WL 3910286, at *6 (S.D.N.Y. Sept. 29, 2010) (quoting Copeland v. Fortis, 685 F. Supp. 2d 498, 506 (S.D.N.Y. 2010)).
The Second Circuit Court of Appeals has issued two opinions that appear to support different conclusions. In its 2012 decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, the Second Circuit decided that the determination of whether a transaction was sufficiently domestic to create the possibility of 10(b) liability turned on “facts suggesting that [either] irrevocable liability was incurred or title was transferred within the United States.” 677 F.3d 60, 68 (2d Cir. 2012). This would support the conclusion that a purchaser of unlisted ADRs would be able to sustain a suit under Section 10(b) under the second prong of Morrison.
A 2014 decision in the Porsche Auto Holdings case seems to suggest a different conclusion. There, the Second Circuit determined that, while a domestic securities transaction is necessary, it is insufficient to confer standing under Morrison without a further examination of the “character” of the security at issue to determine whether the transactions are “so predominantly foreign as to be impermissibly extraterritorial.” Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198, 216 (2d Cir. 2014). Notably, the Porsche Auto Holdings case involved swap securities in which the holder of the swap never acquired title or ownership of the referenced security and the swaps were unsponsored such that the defendant company had no involvement with or awareness of the securities. Because of this, the swaps did not fall under the standard articulated in Absolute Activist Value Master Fund Ltd.
The fate of unlisted ADR holders may be determined in the pending In re Tesco PLC Securities Litigation, No. 1:14-cv-08495 (S.D.N.Y.). This suit, in which motions to dismiss are currently being briefed, involves unlisted ADRs and is being heard by Judge Richard Berman in the Southern District of New York (the same judge who decided In re Société Générale Sec. Litig.). We also expect similar issues to arise in connection with the recently filed cases involving Volkswagen’s unlisted ADRs.
Until these issues are resolved, ADR investors should understand that investments in unlisted ADRs may not carry with them protections under U.S. law and, in particular, Section 10(b) of the Securities Exchange Act.