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Foreign exchange transactions are not considered securities under New York’s Martin Act, Southern District Judge John F. Keenan has ruled. Keenan said “these transactions resemble a contractual wager based on movements in specified foreign-currency prices, without a real possibility of foreign currency changing hands.” The decision was one of several summary judgment rulings Keenan made in Lehman Brothers Commercial Corporation v. Minmetals International Non-Ferrous Metals Trading Company, 94 Civ. 8301 on the eve of a trial in the Southern District of New York. In 1994, Lehman Brothers filed suit charging that the defendant Chinese companies were responsible for multimillion-dollar margin calls on trades involving currency exchanges, interest-rate swaps and Thai baht-denominated negotiable certificates of deposit (NCDs) made by a man named Hu Xiangdong. The issue was whether Hu, an employee of Non-Ferrous Metals Trading Company, was authorized to make the trades on behalf of Non-Ferrous or its parent, Minmetals, both of which are state-controlled companies based in Beijing. The defendants, who argued that Hu was not authorized to make the trades, counterclaimed, charging Lehman Brothers with breach of fiduciary duty, negligence and negligent misrepresentation. While Lehman Brothers argued that the Martin Act barred the counterclaims, the defendants contended the transactions were not “securities” under the Act. The Martin Act, New York General Business Law � 352, allows for the state attorney general to prosecute actions involving the sales of securities — and it is an open question whether private rights of action are pre-empted by the Act. But Judge Keenan said he did not need to take sides on the issue of pre-emption because the trades at issue could not be considered securities. Keenan said the act defines securities as any “stocks, bonds, notes, evidences of interest or indebtedness or other securities,” and also outlines a category called “other securities” which includes “foreign currency orders, calls or options.” “Lehman argues that the FX [Foreign Exchange] transactions fall within this foreign-exchange grouping,” Keenan said. “The court disagrees.” The judge said Lehman Brothers had acknowledged in motion papers that “no physical exchange of the underlying foreign currencies took place in connection with the trading activity,” and that “the foreign currency trades were placed, and at expiration — when the currency would otherwise trade hands — new positions were entered into that either rolled the trades further into the future or offset them with trades taking the opposite position.” That acknowledgment, Judge Keenan said, made the trades more like “a contractual wager.” “Unlike with an option, neither party here, for all intents and purposes, had a right to take possession of foreign currency,” he said. “Accordingly, the court concludes that the Martin Act reference to foreign currency orders does not apply to a series of contracts that relate to foreign-currency prices, but, for all practical purposes, really do not anticipate an exchange of foreign currency positions.” THREE-PART TEST But the analysis does not end there, Judge Keenan said, noting that New York courts have traditionally applied the “classic” three-part test for determining whether a transaction is an “investment contract,” outlined by the U.S. Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Under Howey, a security is the functional equivalent of an investment contract where a person “invests” his money in a “common enterprise” and is led to “expect profits solely from the efforts of the promoter or third party.” Judge Keenan said that the “FX transactions at issue do not satisfy the commonality prong under the Howey test … because the structure of the transactions indicates that any gain likely would result in large part from market movements, not from capital appreciation due to Lehman’s efforts,” and cannot be considered securities under the Martin Act. Applying a similar analysis to the interest rate swaps, Judge Keenan found those trades also fell short of the Howey test. Keenan then found that the negotiable certificates of deposit, (NCDs), qualified as “other securities” under the Martin Act, in part because “the investor may have relied on the skill and advice of the investment firm.” Nonetheless, Keenan found the defendants’ negligence-based counterclaims against Lehman Brothers are not barred because the NCDs were not “offered or sold ‘within or from’ New York,” as required by the act. The trades at issue, he said, were negotiated by Lehman Brothers traders in London and Hong Kong, and negotiated with Hu in Beijing. Lehman Brothers had better luck on some of Keenan’s other rulings. Among them, the judge granted summary judgment for the company on the defendants’ common-law “unsuitability” claim — a claim based on the argument that Lehman is obligated to make trading recommendations that are suitable for the customer. The judge also granted summary judgment for Lehman on the defendants’ claim that Lehman Brothers subsidiaries had committed “markup fraud” — exacting excessive markups on the NCDs and the swap transactions. Jonathan D. Polkes of Cadwalader, Wickersham & Taft’s New York office represented Lehman Brothers. Aaron Rubinstein of Kaye Scholer’s New York office represented the defendants.

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