Pitfalls of underwriting non-US issuers: unsponsored ADRs and other considerations in light of Toshiba

An important consideration for directors and officers (D&O) liability insurers in the underwriting of non-US issuers is an assessment of the risk that such issuers could someday be held liable under the United States’ federal securities laws.

The impact of Morrison

Potential exposure for non-US issuers came to a head in the United States Supreme Court’s 2010 decision in Morrison v National Australia Bank, which established a test to determine the potential extraterritorial reach of Section 10(b) of the Securities Exchange Act 1934. Specifically, the Supreme Court held that Section 10(b) applies only to: (1) transactions in securities listed on domestic exchanges or (2) domestic transactions in other securities.

Morrison, however, seemingly left certain issues open, and federal courts have continued to grapple with the meaning and scope of the second Morrison prong. Recent decisions in the Ninth Circuit Court of Appeals and the Central District of California have taken a potentially expansive view of Morrison, indicating that non-US issuers with American Depositary Receipts (ADRs) trading in the United States may be held liable in securities class action lawsuits in the United States, even where such ADRs are unsponsored by the non-US issuer. Given that securities lawsuits against non-US issuers remain at elevated levels, the interpretation of Morrison’s second prong is likely to be a significant issue of interest moving forward. However, as D&O insurers continue to navigate this uncertainty, the presence of certain issuer characteristics may prove material when assessing the risks faced for non-US issuers.

Stoyas v Toshiba

On January 28, 2020, after remand from the Ninth Circuit Court of Appeals, the Central District of California held in Stoyas v Toshiba, that non-US issuers whose Level I ADRs trade in the United States may be subject to liability under the United States’ federal securities laws. The court’s interpretation of Morrison has notable implications for both non-US issuers who avail themselves of the United States financial markets as well as D&O underwriters.

Toshiba, whose securities are traded on the Tokyo Stock Exchange, has unsponsored Level I ADRs that trade over-the-counter (OTC) in the United States. Notably, Toshiba’s ADRs were considered unsponsored, which means that such securities were established by investment banks in the United States without Toshiba’s involvement. Toshiba’s ADRs were also considered Level I, which do not qualify to trade on national exchanges and are traded exclusively on OTC markets. Nevertheless, after certain alleged accounting improprieties, Toshiba was sued in a securities class action lawsuit in California. The Central District of California initially dismissed the case, holding that the OTC market on which Toshiba’s ADRs traded was not a domestic exchange and that the plaintiffs failed to allege a domestic transaction, per the Supreme Court’s test in Morrison.

The dismissal was reversed on appeal, where the Ninth Circuit Court of Appeals gave the plaintiffs leave to establish that they had sufficiently alleged a domestic transaction under Morrison’s second prong. In doing so, the Ninth Circuit adopted the Second Circuit Court of Appeals’ decision in Absolute Activist Value Master Fund Ltd v Ficeto, which held that in order to establish the existence of a “domestic transaction” in other securities under the second Morrison prong, a plaintiff “must allege facts suggesting that either irrevocable liability was incurred or title transferred within the United States.”

On remand, the Central District of California found that the plaintiffs did in fact sufficiently allege that their purchase of Toshiba’s unsponsored Level I ADRs was a domestic transaction, because they had incurred “irrevocable liability.” Of particular significance to the court’s decision was the fact that the ADRs were created by Bank of New York Mellon, one of Toshiba’s largest shareholders. Accordingly, the court found that it was likely that Toshiba had provided its implied consent to the sale of its ADRs in the United States. The court also considered other factors to meet the Morrison test, including the location and efforts of the broker, where the passing of title occurred, the placement of purchase orders, and where payment was made.


From an underwriting perspective, there are a number of factors that D&O underwriters may consider in light of Morrison and its progeny when evaluating the risks faced by non-US issuers with unsponsored ADRs that trade in the United States.

First, underwriters may seek information about the composition of the issuer’s shareholder base including, in particular, the presence of large institutional investors, and whether such investors have made clear their intention to issue ADRs based on their holdings of the issuer’s stock. If, as was the case for Toshiba, the ADRs were issued by a large shareholder, the issuer may be more likely to find itself being subjected to the federal securities laws.

Underwriters may also consider evaluating whether the issuer participated in, assisted, or affirmatively consented to the issuance of its ADRs, even if unsponsored, as the presence of such factors may indicate that the issuer was actively attempting to avail itself of the United States’ capital markets. Conversely, the risk of exposure to the federal securities laws may be mitigated if the issuer has expressly and specifically disclaimed its intention to have its shares converted into ADRs.

It is also worth noting that securities lawsuit filings against non-US issuers appear to be on the rise. While over 50 such actions were filed in 2018, that number rose to over 60 in 2019. It remains to be seen whether the Toshiba decision will embolden the plaintiffs’ bar, but underwriters may wish to take notice of the significant potential implications for non-US companies whose ADRs trade in the United States.

Read others items in Professions and Financial Lines Brief - May 2020