Corporate Governance

Morrison, Tourre, and the Misguided Interpretation of Rule 10b-5 (The Exclusion of ADRs from the Protections of Rule 10b-5) (Part 5)

By J Robert Brown Jr.

We are discussing Morrison v. National Australia Bank, 130 S. Ct. 2869 (June 24, 2010), the Supreme Court case that held Rule 10b-5 does not have extraterritorial effect and the misreading of the decision by the lower courts.

The misreading of Morrison can be seen most clearly in connection with the treatment of ADRs. See City of Monroe Emples. Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 656 n. 2 (6th Cir 2005) ('An American Depository Receipt, or "ADR," represents ownership in a security issued by a foreign company in foreign markets. Typically, a United States depository bank has custody of the security corresponding to an ADR and issues the ADR certificate to a United States investor.'). 

One issue is whether ADRs result in the underlying security being treated as listed on a national exchange.  The argument is strong that it does but in fact Morrison in a sub silencio fashion largely eliminated that argument.   Because Morrison involved ADRs traded on the NYSE, see 30 S. Ct. 2869 (June 24, 2010) ('There are listed on the New York Stock Exchange, however, National's American Depositary Receipts (ADRs), which represent the right to receive a specified number of National's Ordinary Shares.'), the Court, without any analysis, apparently concluded that neither the ADRs nor their underlying securities are listed for purposes of the application of Section 10(b).  See also In re Royal Bank of Scotland Group, 2011 US Dist. 3974 (S.D.N.Y. Jan. 11, 2011) (rejecting argument that ADRs traded on the NYSE resulted in shares being 'listed' on the Exchange under Morrison; court noted that 'Plaintiffs arguments are also badly undercut by the fact that the issuer in Morrison - National Australia Bank -  had ADRs trade on the NYSE). 

What Morrison did not address, however, was whether investors purchasing ADRs in the US could avail themselves to the protections of Section 10(b) and Rule 10b-5.  One of the plaintiffs in the case (Morrison himself), had in fact purchased ADRs.  His cause of action, however, had been dismissed (see Morrison, at n. 1) and was not therefore part of the appeal.  The plaintiffs left in the case at the time of the appeal were Australians who purchased shares of NAB in Australia.    

Since ADRs are apparently not considered to be listed securities, the only analysis left under Morrison is whether the transaction itself occurred in the United States.  In the case of US investors, it is likely that the purchase or sale of an ADR will occur in the US.  See In re Royal Bank of Scotland Group, 2011 US Dist. 3974 (S.D.N.Y. Jan. 11, 2011) (suggesting that ADRs purchased on NYSE would be sufficient nexus to establish US jurisdiction). 

Nonetheless, some courts have suggested that ADRs, because they involve foreign securities, are categorically excluded from Section 10(b) jurisdictions.  See In re Societe Generale Sec. Litig., 2010 US Dist. Lexis 107719 (S.D.N.Y. Sept. 29, 2010) (antifraud provision did not apply to transaction in ADRs because trades in the securities are 'considered to be a ‘predominantly' foreign securities transaction').  See also In re Societe Generale Sec. Litig., 2010 US Dist. Lexis 107719 (S.D.N.Y. Sept. 29, 2010) ('SocGen's ADRs ‘were not traded on an official American securities exchange; instead, ADRs were traded in a less formal market with lower exposure to U.S. – resident buyers.' Id. (internal citations omitted).  Trade in SocGen ADRs is a ‘predominantly' foreign securities transaction.'). 

Yet Morrison did not exclude ADRs, even if based on a foreign security.  The applicable portion of the test in Morrison looks not to the nature of the security (foreign or domestic) but to the location of the transaction.  Since the ADR (rather than the underlying shares) is the relevant security and, in most cases, the purchase or sale will occur in the US, jurisdiction, contrary to the analysis in Societe Generale does exist under the analysis in Morrison.

Courts saying otherwise have it wrong.

For primary materials on SEC v. Tourre, go to the DU Corporate Governance web site.  For primary materials on Morrison v. NAB, go to the DU Corporate Governance web site.?

Full post as published by The Race to the Bottom on February 23, 2011 (boomark / email).