In Morrison v. National Australia Bank Ltd., the Supreme Court held that Section 10(b)’s fraud prohibition only applies to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.” In the 22 months since the high court decided Morrison, its jurisdictional bar has been broadly extended beyond the case’s narrow, “f-cubed” factual context: foreign plaintiffs suing foreign defendants in connection with securities traded on foreign exchanges. Morrison’s progeny have confirmed that suits against foreign companies involving transactions in securities listed on domestic exchanges will largely be nonstarters.

As for the off-market transactions prong of Morrison, it has remained an open question as to when the purchase or sale of a security that is not listed on a domestic exchange can be considered sufficiently domestic under Morrison. The 2nd Circuit addressed this ambiguity for the first time on March 1 in Absolute Activist Value Master Fund Ltd. v. Ficeto, announcing a standard for “domestic transactions in other securities” that combined the tests the 11th Circuit and the Southern District of New York (SDNY) previously proposed. Per Ficeto, in order to establish the existence of a “domestic transaction in other securities,” a plaintiff “must allege facts suggesting that either irrevocable liability was incurred or title transferred within the United States.” Due to the large volume of cases brought by plaintiffs alleging that U.S. securities laws should apply to nonmarket transactions, the case’s impact could be potentially vast.

Ficeto involves an alleged “pump and dump” scheme that caused the plaintiffs, nine Cayman Islands hedge funds, to suffer losses of at least $195 million through cycles of fraudulent securities trading. Defendant investment managers allegedly caused plaintiffs to purchase billions of shares of thinly capitalized U.S.-based penny stock companies”) directly from those companies in a series of private equity/public equity transactions. All of the penny stock companies involved were incorporated in the U.S., and their shares were listed on the Over-the-Counter Bulletin Board or by Pink OTC Markets, Inc. Defendants artificially inflated the prices of the penny companies’ stocks by trading and re-trading them, often between and among the plaintiff funds, each time at a higher price to create the appearance of a high trading volume. This scheme allegedly enabled defendants to falsely obtain profits by selling shares to the plaintiff funds for a windfall.

The trial court (SDNY) dismissed the complaint in its entirety, reasoning that it lacked subject matter jurisdiction based on Morrison. On appeal, the 2nd Circuit reversed, noting that, per Morrison, whether Section 10(b) applies to certain conduct is a merits question. It then answered the following question: Under what circumstances will the purchase or sale of a security that is not listed on a domestic exchange be considered domestic within the meaning of Morrison?

First, the 2nd Circuit adopted the irrevocable liability test for domestic transactions that had been employed in the SDNY (see, for example, SEC v. Goldman Sachs & Co.), which requires that a plaintiff allege “facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to deliver a security.”

Next, the 2nd Circuit recognized the differing analytical path the 11th Circuit took in Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, in which it held that an allegation that title to the shares was transferred within the U.S. was sufficient to survive a Morrison-based motion to dismiss. Thus, the 2nd Circuit adopted a two-part test: “to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange,” a plaintiff “must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.”

Applying the test, the court concluded that plaintiffs had not sufficiently alleged domestic transactions because the complaint’s sole allegation that affirmatively stated transactions transpired in the U.S. was conclusory. Quoting Morrison, the court emphasized that “the focus of the Exchange Act is…upon purchases and sales of securities in the United States,” rather than the locus of wrongdoing. Nonetheless, the court granted the plaintiffs leave to amend because they had filed their complaint well in advance of Morrison, and seemed to have drafted it with the now-defunct “conduct and effects” test in mind.

The Ficeto court also provided reasons for discarding the other standards advanced by the parties: a broker-dealer’s location could not be used to locate securities transactions because that location alone does not automatically determine where a contract was executed; the fact that stocks are U.S. stocks could not be used to assess domesticity because “the identity of the security [does not] necessarily [have] any bearing on whether a purchase or sale is domestic within the meaning of Morrison,” and Morrison’s second prong refers to “‘domestic transactions in other securities,’ not ‘transactions in domestic securities’ or SEC-registered securities; and a buyer or seller’s identity cannot be used to as a proxy for domesticity because citizenship and residency of a purchaser do not affect where a transaction occurs.

Although Ficeto has provided 2nd Circuit courts with new guideposts, it remains to be seen which complaints will survive the pleadings stage. At first blush, Ficeto seems to increase the potential number of circumstances that may qualify as “domestic transactions in other securities” by combining two tests to create a standard that is broader than the sum of its parts. Yet, by clarifying the contours of the legal standard at the appellate level, Ficeto has made clear that not all allegations of domestic transactions will suffice—only those that meet its strictures.

Given that the lower courts have been extremely skeptical of plaintiffs’ efforts to circumvent the Supreme Court’s transactional test for determining the reach of the securities laws, it will be interesting to see whether, on remand, the Ficeto plaintiffs are able to allege sufficient facts to meet the new standard.