The U.S. Court of Appeals for the Second Circuit has allowed the defendants in the Petrobras securities litigation to pursue an immediate appeal from the District Court’s order certifying classes of investors who had purchased unlisted Petrobras securities in off-exchange transactions.  The appeal in In re Petrobras Securities Litigation could help resolve questions about whether claims arising from off-exchange transactions in unlisted securities can be litigated on a classwide basis even if the U.S. securities laws apply to those transactions (a separate controversial issue).

Factual Background

The impending appeal continues the exploration of the ramifications of the Supreme Court’s 2010 decision in Morrison v. National Australia Bank.  That ruling imposed a transactional test for determining the federal securities laws’ reach and held that those laws apply only to alleged misstatements or omissions made “in connection with the purchase or sale of [i] a security listed on an American stock exchange, and [ii] the purchase or sale of any other security in the United States.”

In subsequent decisions, the Second Circuit held that plaintiffs can satisfy Morrison’s second, more elliptical prong by showing either that they incurred irrevocable liability in the United States for their securities transactions or that title passed in the United States.  The Second Circuit propounded a nonexclusive list of factors to assess whether an off-exchange transaction was a domestic transaction under Morrison:  where the contract was formed; where the purchase order was placed; where title passed; and where money was exchanged.  Allegations about a party’s or a counterparty’s residence or a broker’s location are not necessarily sufficient.  In addition, the Second Circuit has held that, even if a transaction might technically be considered domestic, some claims might nevertheless be so predominantly foreign as to preclude application of U.S. law in light of Morrison’s concerns for international comity and avoidance of promiscuous extraterritoriality.

The Petrobras case posed the question whether the claims of putative class members who had purchased Petrobras’s unlisted securities could be litigated on a classwide basis.  Petrobras argued that, under Second Circuit precedent, the off-exchange purchasers would need to demonstrate either the incurrence of irrevocable liability or the passing of title in the United States – and that such proof would raise so many individualized issues about each transaction that the class members would not be ascertainable before final adjudication and that common issues of fact or law would not predominate over individualized issues.  Petrobras therefore sought to exclude from the class anyone who had purchased Petrobras securities in off-exchange transactions or from non-U.S. underwriters.

In a February 2, 2016 decision, the U.S. District Court for the Southern District of New York denied Petrobras’s request, because the court was “confident that the Morrison determination [concerning the existence of domestic transactions] is administratively feasible” in a class action.  According to the court:

The criteria identified by [the Second Circuit], as relevant to the determination of whether a transaction was domestic, are highly likely to be documented in a form susceptible to the bureaucratic processes of determining who belongs in a class. For example, documentation of “the placement of purchase orders” is the sort of discrete, objective record routinely produced by the modern financial system that a court, a putative class member, or a claims administrator can use to determine whether a claim satisfies Morrison.

Petrobras’s Petition for Leave to Appeal

Petrobras sought leave to file an immediate, interlocutory appeal under Federal Rule of Civil Procedure 23(f), which allows appellate courts to permit appeals of grants or denials of class certification before entry of final judgment. Focusing on the fact that the putative class members had purchased global bonds, which are designed to be traded throughout the world, Petrobras argued that class certification was inappropriate because individualized mini-trials involving issues specific to each note purchaser would be needed to determine who was in the class and whether each purchaser had incurred irrevocable liability for or obtained title to the notes in the United States.

Petrobras maintained that “information about which investors acquired notes in domestic transactions (and how long they held them) is not accessible to defendants or to any readily identifiable third party (such as an exchange)” and that the “information resides, if anywhere, in the bowels of various non-party financial institutions and other securities investors and intermediaries worldwide.” Accordingly, the class’s membership was not ascertainable based on objective, easily administered criteria, and the individualized issues involved in determining the location of each off-exchange transaction predominated over issues common to the putative class as a whole.

The Securities Industry and Financial Markets Association (“SIFMA”) filed an amicus brief in support of Petrobras’s petition.  SIFMA warned that the District Court’s class-certification order could have wide-ranging implications for $85 trillion of currently outstanding debt securities, which predominantly trade over the counter (“OTC”), rather than on exchanges.  SIFMA observed that the District Court’s assumption that the location of transactions could be documented through “the bureaucratic process” is “at odds with the reality of the OTC market,” because “[d]ealers are not required by SEC or FINRA to maintain, and they do not maintain, records of whether a transaction is ‘domestic’ under Morrison.  Nor do trade confirmations indicate this.”  Rather,

[t]rades are typically negotiated informally, over the telephone or instant electronic message. Dealers do not keep records of the sequence of “offer and acceptance,” or of the locations of the ultimate offeror and offeree.  Nor can a dealer know whether it is trading with the agent of an undisclosed principal, including an agent who, after the fact, may allocate the trade to one or more of its principals.  Defendants do not always have, and cannot obtain from non-parties, the information necessary even to approximate the volume of domestic transactions within classes such as this one.

The Second Circuit granted Petrobras’s Rule 23(f) petition on June 15, 2016, and expedited the appeal. We will continue to monitor this important appeal, which could have significant implications for putative class actions involving unlisted securities issued by foreign – and even by domestic – issuers.

We previously blogged about other decisions in the Petrobras litigation hereherehere and here.