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From Securities Regulation Daily, October 18, 2018

Toshiba asks justices to clarify when a domestic transaction is necessary but not sufficient under Morrison

By Mark S. Nelson, J.D.

Toshiba Corporation wants the Supreme Court to reverse a decision by the Ninth Circuit holding that a group of pension funds could re-file their putative securities fraud complaint against the Japanese company because the district court’s misreading of Morrison led it to erroneously dismiss the case with prejudice after finding that further amendment of the complaint would be futile. In Morrison, the Supreme Court explained when Exchange Act Section 10(b) cannot apply extraterritorially. The Ninth Circuit in the case against Toshiba looked at the precise language of Morrison and concluded that amendment of the complaint could result in a valid claim predicated on the pension funds’ buying Toshiba’s unsponsored American Depositary Receipts in over-the-counter markets (Toshiba Corporation v. Automotive Industries Pension Trust Fund, October 15, 2018).

When is a domestic transaction insufficient for Morrison? Toshiba puts the question thus: "…is a domestic transaction necessary and sufficient for application of the Exchange Act, or is a domestic transaction necessary but, by itself, not sufficient for application of the Act?" Toshiba emphasizes the Second Circuit’s decision in Parkcentral (more on this case below), which would be persuasive but not binding in the Ninth Circuit, as the basis for overturning the Ninth Circuit’s decision to let the pension funds amend their complaint against Toshiba.

Specifically, Toshiba asserts that the facts, as filtered through Morrison and Parkcentral, would result in an impermissibly extraterritorial application of the federal securities laws. Toshiba states that the pension funds’ claims involve a domestic transaction to which Toshiba was not a party, that the domestic transaction that did occur involved references to securities traded overseas only, that the cited fraudulent statements were made overseas regarding an overseas company whose shares trade on a foreign exchange, and that foreign investigators had reviewed the allegations against Toshiba.

Toshiba also cites various additional reasons for the justices to take the case. For one, Toshiba notes the "express circuit split" between the Second and Ninth Circuits. The company also observed that these circuits have the highest concentrations of securities class actions, a fact that gives them a "preeminent role" in resolving the attendant legal questions. Moreover, Toshiba said it is concerned that leaving the Ninth Circuit decision in place will encourage forum shopping that could result in an overseas firm being held liable for securities violations in American courts solely because a third party imported the firms’ securities into the U.S. Toshiba also asserts that the Ninth Circuit decision would upset international comity among the world’s securities regulators.

Pension funds may yet plead sufficient facts. A group of pension funds alleged that Toshiba and several of its ex-CEOs enabled an accounting fraud that resulted in restatement of the company’s financials to account for $2.6 billion in inflated pre-tax profits and $1.3 billion in hidden impairment losses related to its U.S. nuclear unit. Toshiba argued to the district court that, under Morrison, there was neither a purchase by the pension funds of Toshiba securities listed on a U.S. exchange nor was there a domestic transaction by Toshiba. As for the first prong of Morrison, the district court found that OTC markets are not domestic exchanges. Under the second prong, the district court concluded that although the ADRs were sold and purchased in the U.S., Toshiba was not involved in those transactions because the ADRs were unsponsored, meaning there was no direct issuer participation. In its view, the district court said the only domestic transaction was between the depositary bank and the pension funds.

By contrast, the Ninth Circuit, although finding the complaint deficient in many ways, concluded that, if given a chance to file another amended complaint, the pension funds might allege facts sufficient to show Toshiba’s involvement in the ADRs. The appeals court cited numerous facts that were raised at oral argument, but not included in the version of the complaint before the court.

With respect to Morrison, the Ninth Circuit distinguished the Second Circuit’s Parkcentral decision as being contrary to the language of Morrison. In Parkcentral, the Second Circuit used the necessary but not sufficient language cited by Toshiba in its certiorari petition and went on to note the predominantly foreign character of the transactions at issue:

Because, in the case of securities not listed on domestic exchanges, a domestic transaction is necessary but not necessarily sufficient to make § 10(b) applicable, we need not decide whether the plaintiffs’ transactions satisfy the standards of Absolute Activist for domestic transactions, because we think it clear that the claims in this case are so predominantly foreign as to be impermissibly extraterritorial (link to case added).

The Ninth Circuit, in a footnote, said the "carve-out" created by Parkcentral had not been cited subsequently by either the Second Circuit or other federal appeals courts (Toshiba’s petition disputed that no other Second Circuit opinion applied Parkcentral). In declining Toshiba’s comity argument, the Ninth Circuit also observed that comity could not push aside the text of Morrison, while noting the possible result: "And it may very well be that the Morrison test in some cases will result in the Exchange Act’s application to claims of manipulation of share value from afar."

As a brief aside, the Ninth Circuit made some additional news in its Toshiba decision, although on a topic not directly at issue in Toshiba’s Supreme Court petition. Under Morrison’s second prong, both the Second and Third Circuits have employed the "irrevocable liability" test regarding whether securities were part of a domestic transaction. The Ninth Circuit said it was adopting this approach.

The case is No. 18-486.

Attorneys: Christopher Curran (White & Case LLP) for Toshiba Corporation.

Companies: Toshiba Corporation; Automotive Industries Pension Trust Fund

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