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Stoyas v. Automotive Industries Pension Trust Fund

United States Court of Appeals, Ninth Circuit

July 17, 2018

Mark Stoyas, individually and on behalf of all others similarly situated, Plaintiff,
v.
Toshiba Corporation, Defendant-Appellee. and Automotive Industries Pension Trust Fund; New England Teamsters & Trucking Industry Pension Fund, Plaintiffs-Appellants,

          Argued and Submitted November 9, 2017 Pasadena, California

          Appeal from the United States District Court for the Central District of California D.C. No. 2:15-cv-04194-DDP-JC Dean D. Pregerson, Senior District Judge, Presiding

          Susan K. Alexander (argued), San Francisco, California, for Plaintiffs-Appellants.

          Christopher M. Curran (argued), Washington, D.C., for Defendants-Appellees.

          Before: Kim McLane Wardlaw and William A. Fletcher, [*] Circuit Judges, and Wiley Y. Daniel, [**] District Judge.

         SUMMARY [***]

         Securities Fraud

         The panel reversed the district court's dismissal and remanded to allow amendment of the complaint in an action in which purchasers of American Depository Shares or Receipts alleged violations of §§ 10(b) and 20(a) of the Securities Exchange Act based on Toshiba Corp.'s fraudulent accounting practices.

         ADRs are financial instruments that enable investors in the United States to buy and sell stock in foreign corporations such as Toshiba, whose common stock is publicly traded on the Tokyo Stock Exchange. The district court concluded that under the test set forth in Morrison v. Nat'l Australia Bank Ltd., 561 U.S. 247 (2010), the Exchange Act, which does not apply extraterritorially, did not apply to the purchase of Toshiba ADRs because the over-the-counter market by which the Toshiba ADRs were sold was not a "national exchange," and there was no domestic transaction between the ADR purchasers and Toshiba.

         Reversing, the panel declined to resolve the question of whether, under Morrison, the Exchange Act applied to "domestic exchanges" or only "national securities exchanges" because the over-the-counter market was not an "exchange" within the meaning of the Exchange Act. The panel nevertheless concluded that the Exchange Act could apply to the Toshiba ADR transactions, as domestic transactions in securities not registered on an exchange. The panel concluded that Toshiba ADRs were "securities" under the Exchange Act. Adopting the Second and Third Circuits' "irrevocable liability" test, looking to where purchasers incurred the liability to take and pay for securities, and where sellers incurred the liability to deliver securities, the panel further concluded that plaintiffs must be allowed to amend their complaint to allege that the purchase of Toshiba ADRs on the over-the-counter market was a domestic purchase, and that the alleged fraud was "in connection with" the purchase.

          OPINION

          WARDLAW, CIRCUIT JUDGE

         In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court held that the presumption against extraterritorial applicability of congressional legislation renders the U.S. Securities Exchange Act of 1934 ("the Exchange Act") applicable to deceptive conduct only in connection with the purchases or sales of any securities registered on a national securities exchange or domestic transactions in other securities not so registered. The Court reasoned that "the focus of the Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States." Id. at 266. Appellants Automotive Industries Pension Trust Fund ("AIPTF") and New England Teamsters & Trucking Industry Pension Fund (together, the "Funds") are named plaintiffs in a putative class action alleging violations of the Exchange Act and the Financial Instruments and Exchange Act of Japan ("JFIEA") against Toshiba Corporation ("Toshiba") based on its now-admitted fraudulent accounting practices that caused hundreds of millions of dollars in loss to U.S. investors. The complaint alleges (1) violation of Section 10(b) of the Exchange Act and Rule 10b-5 on behalf of American Depository Shares or Receipts ("ADRs") purchasers, (2) violation of Section 20(a) of the Exchange Act on behalf of ADR purchasers, and (3) violation of JFIEA Article 21-2 on behalf of ADR purchasers and purchasers of Toshiba common stock. The district court dismissed the case with prejudice on the grounds that the over-the-counter market by which ADRs are sold was not a "national exchange" within the meaning of Morrison, and that there was not any domestic transaction between ADR purchasers and Toshiba. Having dismissed the Exchange Act claims, the district court dismissed the Japanese law claim under principles of comity and forum non conveniens.

         Thus, at the heart of this appeal is the question of the nature of ADRs and their transactions, and whether Toshiba ADRs are covered by the Exchange Act through either registry on a national exchange, or through domestic sales and purchases.

         I. FACTUAL AND PROCEDURAL BACKGROUND

         In the wake of Toshiba's admission of substantial institutional accounting fraud and accompanying restatements of pre-tax profits, [1] Mark Stoyas filed this securities fraud class action on June 4, 2015, against Toshiba, its current chief executive officer, and its former chief executive officer based on his ownership of thirty-three Toshiba ADRs and a loss of $180.53. Later, AIPTF became lead plaintiff based on its purchase on March 23, 2015, of 36, 000 Toshiba ADRs in the United States on an over-the-counter market run by OTC Markets Group and a loss of $196, 913.47.[2] The Funds filed the first amended complaint ("FAC") on December 17, 2015. The FAC added New England

         Teamsters & Trucking Industry Pension Fund as a named plaintiff; unlike AIPTF, it had purchased 343, 000 shares of Toshiba common stock on the Tokyo Stock Exchange.

         The FAC alleges three class action claims for relief against Toshiba.[3] The first two claims are brought on behalf of a class of all persons who acquired Toshiba ADRs ("ADR class") between May 8, 2012, and November 12, 2015 ("Class Period"). The first claim alleges violations of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5. Class members "acquired" Toshiba ADRs "in reliance upon the truth and accuracy" of Toshiba's fraudulent financial statements, paid artificially inflated prices, and suffered economic loss when the ADRs declined in value after the fraud was revealed and pre-tax profits were restated.

         The second claim alleges violation of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a). Toshiba, despite having the ability to control its directors, officers, and managers, including twenty-four specific individuals, failed to prevent their fraudulent conduct or, alternatively, "actively controlled and directed those actions so as to cause the violations" of securities laws.[4]

         The third claim alleges violation of JFIEA Article 21-2. It is brought on behalf of both the ADR class and a class of "all citizens and residents of the United States who otherwise acquired shares of Toshiba common stock during the Class Period." Appellants claim that "Toshiba breached its duty to make a reasonable and diligent investigation of the statements" in its financial reports and "to ensure that the statements contained therein were truthful and accurate." The material false information and omissions artificially inflated the price of Toshiba common stock, and class members were harmed when the value of the stock declined due to the revelation of fraudulent accounting.

         The district court dismissed the FAC with prejudice on May 20, 2016. Applying Morrison, the district court held that the over-the-counter market was not a "stock exchange" within the meaning of the Exchange Act, and that the FAC failed to allege Toshiba's involvement in the ADR transactions at issue, rendering Section 10(b) inapplicable. Having dismissed the Funds' Exchange Act claims, the district court dismissed the Japanese law claim on the basis of comity and forum non conveniens. Finding any amendment would be futile, the district court dismissed the case with prejudice. The Funds timely appeal. Fed. R. App. P. 4(a)(1).

         II. JURISDICTION AND STANDARD OF REVIEW

         The district court had jurisdiction over the Exchange Act claims pursuant to Exchange Act Section 27(a), 15 U.S.C. § 78aa(a). The district court had jurisdiction over the JFIEA claim based on diversity jurisdiction, as Toshiba is a foreign corporation, as well as supplemental jurisdiction, because it arises from the same case or controversy as the Exchange Act claims. 28 U.S.C. §§ 1332(a)(2), (d)(2); 28 U.S.C. § 1367.

         We have jurisdiction pursuant to 28 U.S.C. § 1291 to review the district court's order and final judgment dismissing the Funds' claims with prejudice. See Fed. R. Civ. P. 54(b).

         "We review de novo the district court's grant of a motion to dismiss under Rule 12(b)(6), accepting all factual allegations in the complaint as true and construing them in the light most favorable to the nonmoving party." Fields v. Twitter, Inc., 881 F.3d 739, 743 (9th Cir. 2018) (quotation omitted). "[R]eview is generally limited to the face of the complaint, materials incorporated into the complaint by reference, and matters of judicial notice." New Mexico State Inv. Council v. Ernst & Young LLP, 641 F.3d 1089, 1094 (9th Cir. 2011). In other words, we inquire "whether the complaint at issue contains 'sufficient factual matter, accepted as true, to state a claim of relief that is plausible on its face.'" Harris v. Cty. of Orange, 682 F.3d 1126, 1131 (9th Cir. 2012) (quoting Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)).

         Denial of leave to amend is reviewed for abuse of discretion. Airs Aromatics, LLC v. Opinion Victoria's Secret Stores Brand Mgmt., Inc., 744 F.3d 595, 598 (9th Cir. 2014). "Dismissal with prejudice and without leave to amend is not appropriate unless it is clear on de novo review that the complaint could not be saved by amendment." Harris, 682 F.3d at 1331 (quoting Eminence Capital, LLC v. Aspeon, Inc., 316 F.3d 1048, 1052 (9th Cir. 2003) (per curiam)). "A district court's failure to consider the relevant factors [set forth in Foman v. Davis, 371 U.S. 178 (1962)] and articulate why dismissal should be with prejudice instead of without prejudice may constitute an abuse of discretion." Eminence Capital, 316 F.3d at 1052.

         III. DISCUSSION

         Toshiba's common stock is publically traded on the Tokyo Stock Exchange. The Funds' Exchange Act claims are in connection with Toshiba ADR transactions on the over-the-counter market as opposed to direct purchases of Toshiba common stock. Nevertheless, the Exchange Act applies to Toshiba ADR transactions because Toshiba ADRs are "securities" under the Exchange Act and AIPTF's purchase of Toshiba ADRs on the over-the-counter market is a domestic "purchase or sale of . . . any security not" registered on a national securities exchange. 15 U.S.C. § 78j(b); see Morrison, 561 U.S. at 269-70.

         A. Toshiba ADRs are "Securities"

         The Exchange Act of 1934 applies to "securities," defined to include "any note, stock, treasury stock, security future, . . . transferable share, investment contract, . . . any instrument commonly known as a 'security'; or any . . . receipt for . . . any of the foregoing." 15 U.S.C. § 78c(a)(10); Sec. & Exch. Comm'n v. W.J. Howey Co., 328 U.S. 293, 297 (1946) (describing the definition as encompassing "documents traded for speculation or investment"). This expansive list, along with the Exchange Act's remedial purpose, precludes "a narrow and literal reading of the definition of securities." Warfield v. Alaniz, 569 F.3d 1015, 1020 (9th Cir. 2009); see, e.g., Reves v. Ernst & Young, 494 U.S. 56, 60 (1990) (noting that Congress "painted with a broad brush" the "scope of the market that it wished to regulate" through federal securities laws); Marine Bank v. Weaver, 455 U.S. 551, 555-56 (1982) ("[T]he term 'security' was meant to include 'the many types of instruments that in our commercial world fall within the ordinary concept of a security.'" (quoting H. R. Rep. No. 85 at 11 (1933))); Tcherepnin v. Knight, 389 U.S. 332, 336 (1967) ("[I]n searching for the meaning and scope of the word 'security' in the Act, form should be disregarded for substance and the emphasis should be on economic reality.").

         Toshiba ADRs fit comfortably within the Exchange Act's definition of "security," specifically as "stock." To constitute "stock" under the Exchange Act, an instrument must possess "some of the significant characteristics typically associated" with common stock: "(i) the right to receive dividends contingent upon an apportionment of profits; (ii) negotiability; (iii) the ability to be pledged or hypothecated; (iv) the conferring of voting rights in proportion to the number of shares owned; and (v) the capacity to appreciate in value." Landreth Timber Co. v. Landreth, 471 U.S. 681, 686 (1985) (quotation omitted).

         ADRs "allow U.S. investors to invest in non-U.S. companies and give non-U.S. companies easier access to U.S. capital markets." Sec. & Exch. Comm'n, Office of Inv'r Education and Advocacy, "Investor Bulletin: American Depository Receipts" at 1 (August 2012) [hereinafter "ADR Bulletin"]; see Waggoner v. Barclays PLC, 875 F.3d 79, 84 n.3 (2d Cir. 2017). Specifically, ADRs are negotiable certificates issued by a United States depositary institution, typically banks, and they represent a beneficial interest in, but not legal title of, a specified number of shares of a non-United States company.[5] See Pinker v. Roche Holdings Ltd., 292 F.3d 361, 367 (3d Cir. 2002). The depositary institution itself maintains custody over the foreign company's shares.[6]Id.; ADR Bulletin at 1. There are four depositary institutions for Toshiba ADRs: Bank of New York Mellon, Citibank N.A., Deutsche Bank Trust Company Americas, and Convergex Depositary, Inc.

         Toshiba ADRs are registered with the Securities and Exchange Commission through the filing of Form F-6.[7]17 C.F.R. § 239.36; ADR Bulletin at 2; see City of Monroe Employees Ret. Sys. v. Bridgestone Corp., 399 F.3d 651, 655-56 & n.2 (6th Cir. 2005); Bruns, Nordeman & Co. v. Am. Nat. Bank & Tr. Co., 394 F.2d 300, 304 n.4 (2d Cir. 1968) (stating that the Securities and Exchange Commission started requiring registration of ADRs in 1955). Toshiba ADRs are unsponsored, which means that the depositary institutions each filed Form F-6 without Toshiba's "formal participation" and possibly without its acquiescence. American Depository Receipts, Securities Act Release No. 33-6984, Exchange Act Release No. 34-29226, 56 Fed. Reg. 24, 420, 24, 422 (May 23, 1991) [hereinafter "1991 SEC ADR Release"]; 2003 SEC ADR Release at 54, 645. Accordingly, when AIPTF purchased Toshiba ADRs, it was entering into "essentially a two-party contract" with the depositary institution.[8] 2003 SEC ADR Release at 54, 645. The contractual terms are specified in the ADR itself, to which ADR holders are "deemed to have agreed . . . by their acceptance and holding of ADRs." Batchelder v. Kawamoto, 147 F.3d 915, 919 (9th Cir. 1998) (quoting 1991 SEC ADR Release).

         Toshiba ADRs share many of the five significant characteristics typically associated with common stock. See Landreth Timber, 471 U.S. at 686. First, depositary institutions transfer the dividends they receive on deposited Toshiba common stock to the corresponding Toshiba ADR owner.[9] Second, Toshiba ADRs are negotiable: they are traded through U.S. broker-dealers; collectively, the depositary institutions have registered 205 million Toshiba ADRs; Toshiba ADRs are owned "by hundreds of thousands of persons"; and Toshiba ADR holders may split or combine Toshiba ADRs into new instruments as they see fit. Pinker, 292 F.3d at 367 ("ADRs are tradeable in the same manner as any other registered American security."); In re Hawaii Corp., 829 F.2d 813, 815 (9th Cir. 1987) (defining negotiability). Third, nothing in the Toshiba ADRs restricts pledging or hypothecation. Fourth, each of the four Toshiba ADR depositary institutions is willing to exercise the voting rights associated with the deposited Toshiba common stock as directed by the Toshiba ADR owners. Fifth, Toshiba ADRs have the same "interest . . . in the management, profit and assets" of Toshiba as investors in ...


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