The 2nd U.S. Circuit Court of Appeals on Thursday refused to categorically bar foreign plaintiffs from suing in U.S. courts foreign issuers of securities for violations of U.S. securities laws based on transactions in foreign countries.
Declining to adopt a bright-line rule barring so-called "foreign-cubed" securities transactions, the court cited the shared goal of governments around the world to combat securities fraud as one policy reason for largely adhering to its precedent in determining that jurisdiction should be determined on a case-by-case basis.
The decision in Morrison v. National Australia Bank Ltd., 07-0583-cv, did not help the plaintiffs, however, as the circuit affirmed the dismissal of the action for lack of subject matter jurisdiction because the "heart of the fraud" lay outside the United States.
Judges Jon Newman, Guido Calabresi and Barrington D. Parker decided the first "foreign-cubed" or "f-cubed" case to appear at the 2nd Circuit. Parker wrote for the court in affirming the dismissal by Southern District Judge Barbara Jones.
The case was closely watched by the securities industry and drew amici from the Washington Legal Foundation, the Association of Corporate Counsel, the U.S. Chamber of Commerce and the Securities and Exchange Commission.
The case involves the National Bank of Australia, which purchased U.S. mortgage service provider HomeSide Lending Inc. in 1998. But by 2001, the bank was forced to admit that its calculations on the amount of fees HomeSide was generating from servicing mortgages were incorrect. This led to the bank announcing two write-downs in 2001 totaling $2.2 billion.
As a result, both the bank's shares, which do not trade on U.S. exchanges, and its American Depository Receipts, which trade on the New York Stock Exchange, dropped in value, leading to the lawsuit. Depository receipts make up only a fraction of the bank's securities.
Three plaintiffs who purchased shares abroad and a fourth who purchased the depository receipts sought to represent two classes in the Southern District of New York litigation.
Jones dismissed the foreign purchasers for lack of subject matter jurisdiction and the domestic plaintiff for failure to state a claim.
Parker observed that the appeal presented the "vexing question of extraterritorial application of the securities laws."
The judge noted that "[h]arm to domestic interests and domestic investors has not been the exclusive focus of the anti-fraud provisions of the securities laws," and that the court has inferred Congress wanted to redress harms inflicted abroad that have a substantial impact on markets or investors in America.
In Psimenos v. E.F. Hutton & Co., the court said the extraterritorial reach of §10(b) of the Securities and Exchange Act of 1934 is determined by the "conduct test" and the "effects test," where the court asks "whether the wrongful conduct occurred outside the United States" and "whether the wrongful conduct had a substantial effect in the United States or upon a United States citizen."
Importantly, the court said, the two tests can be applied collectively.
Here, the plaintiffs were relying on the conduct portion of the test, under which Parker said there is subject matter jurisdiction "if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad."
'HEART OF THE FRAUD'
The plaintiffs had argued below that the fraud primarily occurred in the United States because HomeSide was based in Florida. But Jones, while noting it was "a close call," disagreed, saying there would have been no securities fraud "but-for (i) the allegedly knowing incorporation of HomeSide's false information; (ii) in public filings and statements made abroad; (iii) to investors abroad; (iv) who detrimentally relied on the information in purchasing securities abroad."
Parker said that "despite the unusual fact pattern, the usual rules still apply."
The most recent application of those rules came in SEC v. Berger, 322 F.3d 187 (2003), where the 2nd Circuit held that subject matter jurisdiction existed because the defendant's fraudulent scheme was "masterminded and implemented" in the United States, even though statements that conveyed the fraudulent information were mailed from Bermuda.
The judge said that determining what is at the heart of the scheme as opposed to what is "preparatory" or "ancillary" can be "an involved undertaking."
The bank and some amici argued for a "bright-line rule" for foreign-cubed securities cases, whereby domestic conduct is insufficient and jurisdiction should not lie where there is no effect on U.S. markets or investors.
"In support of their position, Appellees and amici point to a parade of horribles," Parker said, including that allowing such suits would "undermine the competitive and effective operation of American securities markets, discourage cross-border economic activity, and cause duplicative litigation."
Their biggest objection was the conflict between U.S. securities laws and those in other countries, such as Canada, which does not recognize the fraud on the market doctrine, or other countries where class actions are not allowed or difficult to bring.
But Parker said the potential conflict does not require "the jettisoning of our conduct and effects test" because conflict of laws "is much less of a concern when the issue is the enforcement of the anti-fraud sections of the securities laws than with such provisions as those requiring registration of persons or securities."
On the former, he said, the "anti-fraud enforcement objectives" in different countries are "broadly similar."
And rejecting all foreign-cubed actions, he said, "would conflict with the goal of preventing the export of fraud from America."
Nonetheless, having decided to stick with the test and eschewing the adoption of "rigid, bright-line rules," the court found that the heart of the fraud here occurred outside the United States.
John C. Coffee Jr. a professor of law at Columbia University School of Law and New York Law Journal columnist, has argued that opening up U.S. courts to foreign-cubed actions harms U.S. competitiveness by increasing the migration of capital overseas.
Coffee, who is not involved in the case, said yesterday's decision makes some progress by requiring "a shorter chain of causation" in the conduct test, but that the larger problem remains, because the Second Circuit "clearly contemplates that there will be occasions where f-cubed transactions can be litigated here."
He added, "That leaves considerable residual fear in the hearts of a foreign issuer who does not have to face the prospect of class litigation in their home country and thus only encounters it by entering the United States."
While people like to blame the "already significant migration" of capital off shore on Sarbanes-Oxley, he said, "that doesn't do much compared with the threat of a billion dollar class action."
Thomas A. Dubbs of Labaton Sucharow & Rudoff represented the plaintiffs.
Dubbs issued a statement saying he was disappointed in the outcome but that the rejection of a bright-line test by the court was "good news for investors."
George T. Conway of Wachtell, Lipton, Rosen & Katz represented the bank. He called the decision "a tremendous victory for foreign companies." "The court's decision makes clear that a paramount consideration in determining whether a U.S. court can hear an f-cubed case is whether the statements were made by the foreign issuer itself in the foreign country, and if that's the case, it is going to be very difficult for the plaintiffs to sustain the case," Conway said.
While the court did not slam the door on f-cubed cases, Conway said, "this is a decision that's going to effect a lot of cases in the Southern District."
He added, "There's been a plague of this kind of litigation and the fact pattern that exists in my case is a very common fact pattern. If the courts faithfully follow this decision, a lot of this litigation will have to be dismissed."