In 2010, the U.S. Supreme Court ruled in Morrison v. National Australia Bank Ltd. that Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act) does not apply extraterritorially.1 According to the Supreme Court, this bedrock anti-fraud provision of U.S. securities law applies only to “transactions listed on domestic exchanges and domestic transactions in other securities.” Since Morrison was decided, plaintiffs’ lawyers have been testing the limits of what constitutes a “domestic” transaction for purposes of a federal securities fraud claim. On May 6, 2014, the U.S. Court of Appeals for the Second Circuit defined some of those limits. In City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG, the Second Circuit held that Morrison precludes claims arising out of foreign-issued securities purchased on foreign exchanges, even if the securities were cross-listed on a domestic exchange. The Second Circuit further held that mere placement of a buy order in the United States for the purchase of foreign securities on a foreign exchange is insufficient to establish a “domestic transaction” under the Exchange Act.2
Background on City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG
The plaintiffs in City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG (City of Pontiac) were foreign and domestic institutional investors who purchased shares of Swiss-based UBS AG (UBS) that were listed on foreign exchanges and crosslisted on the New York Stock Exchange. The plaintiffs alleged, among other things, that UBS (and certain of its former officers and executives) violated the Exchange Act by making purportedly misleading statements regarding UBS’s mortgage-related assets portfolio and compliance with U.S. tax and securities laws.3 On September 13, 2011, a judge in the U.S. District Court for the Southern District of New York dismissed the claims of the plaintiffs who purchased UBS shares on foreign exchanges, relying on the Supreme Court’s Morrison decision that barred the extraterritorial application of U.S. securities laws.4
Just this week, a Second Circuit panel unanimously affirmed the District Court’s dismissal with prejudice.
The Second Circuit’s Ruling On What Constitutes A Domestic Transaction
The Second Circuit considered, and rejected, two principal arguments as to why Morrison permitted the plaintiffs to bring suit based on purchases of foreign shares on foreign exchanges. First, the Second Circuit addressed the plaintiffs’ so-called “listing theory”—that because the relevant shares were cross-listed on the New York Stock Exchange, they came within the purview of the Exchange Act. Specifically, the plaintiffs contended that, under Morrison, their purchase of these shares were “transactions in securities listed on domestic exchanges.”
The Second Circuit disagreed. According to the court, the relevant inquiry under Morrison is not the location of an exchange where securities may be dually listed, but rather the location of the securities transaction. Thus, so long as the plaintiffs’ UBS shares were purchased outside the United States on foreign exchanges, the fact that the shares were also listed in the United States could not support the application of Section 10(b) of the Exchange Act. The Court held: “In sum, Morrison does not support the application of [Section 10(b)] to claims by a foreign purchaser of foreign issued shares on a foreign exchange simply because those shares are also listed on a domestic exchange.”5
Second, a U.S.-based plaintiff argued that, by placing a “buy order” in the United States for foreign securities to be purchased on a foreign exchange, the plaintiff satisfied the other prong of Morrison, which allows Exchange Act claims based on a “domestic transaction in other securities.” The panel rejected this theory too, applying the Second Circuit’s 2012 decision in Absolute Activist Value Master Fund Ltd. v. Ficeto.6 In Absolute Activist, the Court of Appeals held that “[a] securities transaction is domestic [for purposes of Morrison’s second prong] when the parties incur irrevocably liability to carry out the transaction within the United States or when title is passed within the United States.”7
As a matter of first impression, the Second Circuit concluded in City of Pontiac that “the mere placement of a buy order in the United States” was insufficient to establish “that a purchaser incurred irrevocable liability in the United States, such that the U.S. securities laws govern the purchase of those securities.” The court also noted that “a purchaser’s citizenship or residency does not affect where a transaction occurs.”8 Accordingly, the panel affirmed the judgment of the District Court dismissing the claims of a domestic purchaser insofar as the claims were based on purchases of foreign shares on foreign exchanges.
The Second Circuit’s City of Pontiac decision helps clarify when the purchase of foreign securities will, or will not, be subject to Section 10(b) claims. At least in the Second Circuit, it is the location of the securities transaction, not the location of an exchange where the securities happen to be listed, that will determine whether investors in foreign securities can bring suit under Section 10(b) in the United States. Moreover, the Second Circuit has made clear that a transaction will not be considered “domestic” simply because a buy order was placed in the United States. The Morrison bar on extraterritorial suits therefore applies to so-called “foreign-squared” transactions involving a foreign defendant and foreign securities, as well as to “foreign-cubed” transactions involving a foreign plaintiff, foreign defendant, and foreign securities. The Second Circuit left open the question of what exactly a plaintiff must plead in order to establish that a purchase of foreign securities is a “domestic transaction” for purposes of bringing a Section 10(b) claim.