Two recent developments in US class action law demonstrates the extraterritorial reach of US securities law and represents an emerging risk for Australian companies and their D&O insurers.
A recent ruling by a US judge confirmed that an ongoing class action by holders of American Depository Receipts (ADRs) in Japanese Company Toshiba was allowed to proceed under both US and Japanese Securities law.
Two class actions have been filed by US-based plaintiff class action firms against Westpac Banking Corporation in the United States on behalf of holders of Westpac's American Depository Receipts (ADRs). Both actions relate to losses allegedly resulting from Westpac's AUSTRAC scandal.
In this article, Clyde & Co partners Ned Kirk and Janette McLennan explain the basis for the Westpac class action and discuss the risks that this new class action trend may present for Australian companies.
Extra-territoriality of Jurisdiction of the USA
Australian investors had previously unsuccessfully tried to invoke the extraterritorial protection of US securities laws. In Morrison v National Bank of Australia, Australian investors had tried to sue NAB for losses sustained on shares traded on the Australian Stock Exchange. The US Supreme Court dismissed the claim, holding that the US Exchange Act only applied to:
- Transactions in securities listed on a US Exchange; and
- Domestic transactions in other securities.
Despite the decision in Morrison, investors have continued to file US securities class actions against non-US companies, using a securities product, known as an ADR. In the past two years, the number of securities actions against non-US issuers has more than doubled the historical average.
What is an ADR?
An ADR is a negotiable certificate issued by a US depository bank and represents a specific number of shares in a company listed on a foreign stock exchange. ADRs are traded on US Stock Exchanges or are available on the over-the-counter market (the OTC).
ADRs are an easy way for US investors to trade in foreign shares. There are two basic types of ADRs:
- Sponsored ADRs which are issued on behalf of an international company; and
- Unsponsored ADRs which are issued without the consent of the foreign company.
Approximately 164 Australian companies have ADRs issued in the US available either on stock exchanges or the OTC. In the case of Westpac, its sponsored ADRs have been listed on the NYSE since October 1989, with The Bank of New York Mellon acting as the depositary bank. Each ADR represents one Westpac ordinary, fully paid share traded on the ASX.
The Toshiba Litigation
Toshiba's shares are traded on the Tokyo stock exchange. Its unsponsored ADRs are also traded in the US. In 2015, a class action was filed in a US District Court in California arising from an alleged accounting scandal around its Japanese operations. The case alleges breaches of both US and Japanese securities law. In 2016, the District Court dismissed with prejudice the First Amended Complaint. The defendants appealed, and on 17 July 2018, the Court of Appeals for the Ninth Circuit agreed with the District Court that the First Amended Complaint alleged neither a domestic transaction nor fraudulent conduct in connection with the sale of securities. The Ninth Circuit, however, allowed the plaintiffs an opportunity to re-plead. The Supreme Court denied a petition to review the appeal in June 2019. On 8 August 2019, the plaintiffs filed a Second Amended Complaint, which the defendants moved to dismiss.
In a recent ruling, Judge Pregerson denied the defendants' motion to dismiss the Second Amended Complaint. He first found that the plaintiffs' allegations supported their contention that the trades had taken place in the US and were a domestic transaction as required under Morrison. Specifically, the plaintiffs plausibly alleged that they incurred irrevocable liability in the US, including that the location of the broker, tasks carried out by the broker, placement of the purchase order, passing of title, and payment for the ADRs all occurred in the US. The court noted, however, that if discovery reveals that the ADR transaction involved an initial purchase of Toshiba's common stock in a foreign transaction, as the defendants argued, this fact could be properly raised later in the case on a motion for summary judgment to show that the plaintiffs' purchase of the ADRs were not domestic transactions.
Next, the District Court found that the Second Amended Complaint sufficiently alleged that the alleged fraudulent conduct was in connection with the purchase or sale or securities as required under the Exchange Act. Toshiba argued that the plaintiffs could not prove a causal link between Toshiba's alleged conduct and their decision to invest in the ADRs. As unsponsored ADRs, issued without its consent, Toshiba had not participated in the transaction. The Judge dismissed this argument, finding that the depository bank held 55 million of Toshiba shares, and was one of Toshiba's largest shareholders. The Judge determined that it was unlikely that the depository bank could have purchased such a large number of shares on the open market without Toshiba's consent, assistance or participation. Therefore, the District Court determined that the plaintiffs sufficiently alleged Toshiba's "plausible participation in the establishment of the ADR program."
The ruling confirms that Australian companies, with unsponsored ADRs, are at risk of not only Australian class actions but also potential US class actions as well.
The Westpac Class Actions
The Westpac class action related to allegations by Australia's financial intelligence agency, AUSTRAC, that the bank breached Australia's anti-money laundering and counter-terrorism finance laws (AML/CTF) by failing to report AUD23million international funds transfer instructions (IFTIs) on behalf of correspondent banks and their customers. As a result, AUSTRAC has commenced proceedings in the Federal Court of Australia for a civil penalty proceeding. The penalty could be more than AUD1billion, when compared to the recent penalty action against the Commonwealth Bank of Australia following 53,000 breaches of Australia's AML/CTF laws.
In December 2019, a class action against Westpac was filed in the Federal Court of Australia by Phi Finney McDonald Lawyers. Woodsford Litigation Funding funds this class action.
On 30 January 2020, the Rosen Law Firm, which is a US-based plaintiff class action firm, filed proceedings against Westpac Banking Corporation in the US District Court for the Eastern District of New York, on behalf of holders of Westpac's sponsored ADRs. On 3 February 2020, a second US class action was filed by another US-based plaintiff class action firm, Bernstein Liebhard.
The allegations covering both the Australian and US class actions are the same and as the Australian class action is currently an open class, the US investors would also be potentially covered by the Australian proceeding. For the moment it means that Westpac will need to defend itself from actions by its investors in two jurisdictions.
The Westpac claims demonstrate that Australian companies are now in the sights of US plaintiff class action firms. Under Morrison, they are are able to bring US securities class actions against companies with sponsored ADRs. In addition, Australian companies with unsponsored ADRs may have exposure to US securities class actions, at least in the Ninth Circuit pursuant to the recent rulings in Toshiba. A significant number of leading Australian companies have unsponsored ADRs traded on the OTC in the US; these include banks, financial services, insurers, mining, oil and gas, and pharmaceutical and biotech companies. Given the number of recently announced class actions against banks and financial services companies and the application of US securities laws to unsponsored ADRs, we may see more US-based class actions against Australian companies in the coming year.
D&O underwriters should turn their minds to consider ADR class actions as an emerging risk for Australian based risks and consider how wordings should respond, with particular care to be exercised when considering DIC/DIL clauses and territorial limits. Also, during the underwriting of D&O policies, the underwriters should carefully consider potential exposure to sponsored or unsponsored ADRs, and request information regarding the insured's consent, participation or assistance with ADRs or other US securities transactions tied to its securities.
For Australian based claims managers, risks can also arise due to differences in insurance law between the US and Australia. Issues can arise if an Australian master policy, with a DIC/DIL clause, provides excess cover to a local US policy. Other potential problems can occur as a result of some US states providing an insured with a right to a defence that is separate from the right to indemnity which may mean that an insurer may have to pay defence costs even if the claim does not explicitly cover the ultimate loss. When considering coverage for such claims, it may not be enough to rely on Australia law and principles and it may be necessary to obtain US law advice.
Finally, class action defence in the US can be costly, and claims managers and in-house counsel need to manage costs carefully. We would recommend appointing monitoring counsel to ensure that proceedings are appropriately resourced and managed.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.