An American lawyer, seated in his midtown Manhattan office, receives a call from a prospective client located halfway around the world, in Sydney, Australia. The client purchased shares of an Australian corporation on the Australian stock exchange — and lost a lot of money. He claims the offering materials were false and misleading, and wants to bring suit. But instead of bringing suit in Sydney, for strategic reasons he wants to commence an action in New York, under U.S. law.
The client has a proposed justification for filing suit in New York. The Australian corporation had a wholly owned subsidiary located in the United States. That subsidiary engaged in improper accounting practices that led to grossly overstated revenues for the subsidiary’s business. Once those overstated revenues were incorporated into the Australian corporation’s financial reports, those reports were also materially misleading. Is that, the client asks, enough to get me into American court?
The 2nd U.S. Circuit Court of Appeals, in a recent case of first impression, considered exactly that question: can a securities fraud complaint brought by foreign plaintiffs against foreign issuers based on foreign stock purchases — a set of circumstances sometimes dubbed a “foreign-cubed securities case” — be heard by a U.S. federal court? Morrison v. National Australia Bank Ltd., 07-0583-CV. The answer provided by the 2nd Circuit: under the right circumstances, yes.
The three plaintiffs at issue in Morrison had bought “ordinary shares” (the equivalent of American common stock) of the National Australia Bank, an Australian corporation. While those shares traded on a number of foreign exchanges — the Australian Securities Exchange, the London Stock Exchange, the Tokyo stock exchange and the New Zealand stock exchange — they did not trade in the United States, and the Foreign Plaintiffs purchased their shares abroad.
Prior to the foreign plaintiffs’ purchases, NAB had acquired a United States corporation, HomeSide Lending Inc., a mortgage service provider headquartered in Jacksonville, Fla. NAB later discovered that HomeSide had engaged in accounting practices that resulted in an overstatement of the company’s financial results. Specifically, HomeSide had calculated the present value of the fees its mortgage servicing business would generate in the future, and booked that amount as an asset. NAB later revealed that the interest assumptions in HomeSide’s valuation model were incorrect and resulted in an overstatement of the value of HomeSide’s servicing rights. As a result of that disclosure, NAB’s ordinary shares fell dramatically in value, and litigation ensued.
Although they had purchased their shares abroad, the foreign plaintiffs brought suit in federal district court in Manhattan, alleging violations of the federal securities laws, including Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder. The foreign plaintiffs claimed that HomeSide had falsified the pertinent data in Florida, and then sent the data to NAB in Australia, where NAB personnel disseminated it via public filings and statements, and that in reliance upon the misleading statements by NAB, they had purchased NAB shares to their detriment.
The district court had dismissed the case for lack of subject matter jurisdiction. In analyzing the issue on appeal, the 2nd Circuit recognized that while the case presented a novel fact pattern — “a set of (1) foreign plaintiffs … suing (2) a foreign issuer in an American court for violations of American securities laws based on securities transactions in (3) foreign countries” (emphasis in original) — the “usual rules still apply.”
Those “usual rules,” as established by prior 2nd Circuit opinions, dictated that subject matter jurisdiction would exist over extraterritorial claims only 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.” In applying this test, the court must “identify which action or actions constituted the fraud and directly caused harm … and then determine if that act or those actions emanated from the United States.”
The 2nd Circuit acknowledged that its usual approach to determining subject matter jurisdiction of extraterritorial claims, which involved “determining what is central or at the heart of a fraudulent scheme versus what is ‘merely preparatory’ or ancillary,” could be difficult to apply. Seizing upon that difficulty, the defendants urged the court to adopt a different standard, a “bright-line” rule precluding the exercise of subject matter jurisdiction in any “foreign-cubed” case where the conduct had no effect within the United States. To do otherwise, they contended, would result in a “parade of horribles,” foremost among them the risk that permitting such actions in the United States would bring our securities laws into conflict with those of other jurisdictions.
The 2nd Circuit rejected defendants’ argument. It concluded that the potential conflict between United States and foreign laws was not a significant obstacle in the case of anti-fraud provisions. As opposed to more specific rules — such as registration requirements, which vary greatly from country to country — the court found that anti-fraud provisions are “broadly similar as governments and other regulators are generally in agreement that fraud should be discouraged.” Moreover, the court noted that to decline jurisdiction over all foreign-cubed securities fraud actions could render the United States a safe haven for securities cheaters, so long as they victimized only foreign shareholders.
By rejecting a bright-line rule, the 2nd Circuit left in place its well-established jurisprudence for addressing the subject matter jurisdiction of extraterritorial claims. Applying the “usual rules” under the facts of this case, the 2nd Circuit went on to conclude that subject matter jurisdiction was lacking. On the facts of this case, then — where the “the actions taken and the actions not taken by NAB in Australia were, in our view, significantly more central to the fraud and more directly responsible for the harm to investors than the manipulation of the numbers in Florida.” — the foreign plaintiffs were unable to sustain United States jurisdiction.
Nevertheless, by rejecting a bright-line rule, the court made clear that, under the right circumstances, even a foreign-cubed case — one involving foreign plaintiffs, foreign issuers and foreign stock purchases — may be brought in United States courts.
Douglas R. Jensen is counsel in the securities litigation and regulatory enforcement practice at Chadbourne & Parke. He is reachable at email@example.com or 212-408-5562