The U.S. Court of Appeals for the Second Circuit has issued a series of decisions addressing the second prong of Morrison and taken the lead among U.S. courts on this issue.

In Absolute Activist Master Fund Ltd. v. Ficeto, 3 the Second Circuit examined whether transactions involving securities that were not traded on a U.S. registered exchange, could still be subject to § 10(b) as “domestic transactions” under Morrison’s second prong. The plaintiffs were Cayman Islands hedge funds that allegedly suffered $195 million in losses in a pump-and-dump scheme by their U.S. broker and investment manager. The defendants allegedly advised the funds to purchase through the U.S. broker penny stocks of thinly capitalized U.S. companies that were not traded on a U.S. registered exchange. The defendants had secretly invested in the stocks, and after causing the funds to purchase the stocks directly from the companies, they allegedly artificially inflated the stock prices for their own benefit.

The court first noted that Morrison provided little guidance as to what constitutes a domestic purchase or sale. Under the Exchange Act, the definitions of the terms “purchase” and “sale” “suggest that the act of purchasing or selling securities is the act of entering into a binding contract to purchase or sell securities.” In other words, “the ‘purchase’ and ‘sale’ take place when the parties become bound to effectuate the transaction.” Accordingly, the point of irrevocable liability determines the locus of a securities purchase or sale. Therefore, the Second Circuit held that Morrison’s second prong applies to securities transactions where (i) the parties incurred irrevocable liability to purchase or deliver a security within the U.S., or (ii) title was transferred within the U.S.

Applying this test to the complaint in Absolute Activist, the court found that the plaintiffs failed to allege facts demonstrating that the purchaser incurred irrevocable liability within the U.S. to “take and pay for a security” or “deliver a security”, or “that title to the shares was transferred within the [U.S.].” Specifically, the court determined that the following facts and allegations alone were insufficient to allege a domestic transaction in the U.S.: (a) a conclusive allegation that the transactions took place in the U.S.; (b) the investors wired money to the funds in the U.S.; (c) the funds were marketed in the U.S.; (d) investors in the U.S. were harmed; (e) certain defendants were U.S. citizens or resided in the U.S.; and (f) some of the fraudulent conduct occurred in the U.S. As these factors did not demonstrate that the purchases and sales were made in the U.S., the court dismissed the complaint, although it allowed plaintiffs to file an amended complaint pleading facts regarding the location of the securities transactions. 

Two years later, the Second Circuit expanded upon its analysis in Absolute Activist in two other cases involving different securities transactions. In City of Pontiac Policemen’s and Firemen’s Retirement System, et al. v. UBS AG, et al.4 , the court examined whether Morrison applied to claims by U.S. investors who purchased securities of a foreign issuer on a foreign exchange through a buy order initiated in the U.S. First, the court rejected the plaintiffs’ so-called “listing theory,” which argued that the dual listing of the securities on both domestic and foreign exchanges satisfied the first prong of Morrison. Next, the court found that “the fact that a U.S. entity places a buy order in the [U.S.] for the purchase of foreign securities on a foreign exchange” did not constitute a domestic transaction under Morrison. As both prongs of the Morrison test focus on the domestic location of the securities transaction, the mere cross-listing of the security on a U.S. exchange is insufficient to satisfy Morrison with respect to claims brought by foreign and American plaintiffs who purchased their shares on a foreign exchange.

Shortly after its decision in City of Pontiac, the Second Circuit revisited Morrison under more complex circumstances in Parkcentral Global Hub Ltd. v. Porsche Auto Holdings SE. 5 In the Parkcentral case, U.S. investors asserted §10(b) claims for losses incurred on swap agreements they purchased in the U.S., but which were tied to the value of Volkswagen shares traded on foreign exchanges. For purposes of the defendants’ motion to dismiss, the court assumed that the swap agreements were executed and performed in the U.S. and the underlying transaction therefore constituted a domestic securities transaction. Nevertheless, the court declined to allow the case to proceed, finding that while a domestic transaction is necessary, it is not alone sufficient under Morrison, as the Supreme Court did not hold that §10(b) applies to any domestic securities transaction. Applying the statute whenever a claim is predicated on a domestic transaction, “regardless of the foreignness of the facts constituting the defendants’ alleged violation, would seriously undermine Morrison’s insistence that §10(b) has no extraterritorial application.”  

In granting the defendants’ motion to dismiss, the district court found that the “value of securities-based swap agreements is intrinsically tied to the value of the referenced security [and] the economic reality is that [the swaps] are essentially ‘transactions conducted upon foreign exchanges and markets,’ and not ‘domestic transactions’ that merit the protection of §10(b).” The Second Circuit determined that applying U.S. securities laws based only on the execution of such swap agreements in the U.S. “would subject to U.S. securities laws conduct that occurred in a foreign country, concerning securities in a foreign company, traded entirely on foreign exchanges, in the absence of any congressional provision addressing the incompatibility of U.S. and foreign law nearly certain to arise.” Therefore, as the claims were “so predominantly foreign as to be impermissibly extraterritorial,” the court held that the transactions did not satisfy the standards for a domestic transaction under Absolute Activist. 

The Second Circuit acknowledged in Parkcentral the complexity of determining the extraterritorial reach of U.S. securities laws under the second prong of Morrison, particularly “in a world of easy and rapid transnational communications and financial innovation,” and declined to adopt a comprehensive rule or “bright-line” test for extraterritoriality in §10(b) cases. Instead, courts must carefully consider the facts of every case “so as to eventually develop a reasonable and consistent governing body of law on this elusive question.” 

In 2016, the Second Circuit revisited Morrison in In re Vivendi, S.A. Securities Litigation.6 Shareholders in Vivendi common stock filed a securities class action against the company, which is a foreign media corporation, and certain of its D&Os. The plaintiffs argued that they incurred irrevocable liability in the U.S. and thus satisfied Morrison’s second prong because they were located in the U.S. when a three-way merger through which they acquired Vivendi ordinary shares was completed. The Second Circuit upheld the dismissal of the securities fraud claims, finding that incurring irrevocable liability means either “becom[ing] bound to effectuate the transaction” or “entering into a binding contract to purchase or sell securities.” The location of the investors in the U.S. who acquired ordinary shares as a result of the merger, but were not parties to the merger, was irrelevant to a determination of whether the merger qualified as a “domestic purchase or sale.” The plaintiffs did not point to any evidence that the parties to the merger otherwise incurred irrevocable liability in the U.S. 

On July 7, 2017, the Second Circuit applied the second prong of Morrison with respect to the certification of plaintiff classes in In Re Petrobras Securities Litigation. 7 In Petrobras, the defendants appealed an order by the district court certifying two plaintiff classes of all otherwise eligible persons who purchased Petrobras ADSs on the NYSE and Petrobras debt securities in “domestic transactions” as defined in Morrison. As the debt securities traded over-the-counter (“OTC”) and not on a domestic exchange, the district court was required to assess whether those securities transactions were domestic transactions under Morrison.

In their appeal, the defendants asserted that the debt securities class failed to satisfy the ascertainability and predominance requirements for class certification because the class members were required to establish on an individual basis that they acquired their securities in a “domestic transaction.”8 With respect to ascertainability, the defendants argued that it would be too difficult to determine which of the OTC trades were “domestic transactions” under Morrison. The Second Circuit disagreed, finding that the district court’s criteria for identifying the securities purchases was “clearly objective”, and it was therefore “objectively possible” to determine whether the debt securities were acquired in domestic transactions.9

Next, the Second Circuit considered whether the predominance requirement for class certification was satisfied, which would require a finding that the resolution of any “material ‘legal or factual questions… can be achieved through generalized proof’, and ‘these [common] issues are more substantial than the issues subject only to individualized proof.’” In Petrobras, this analysis raised two predicate inquiries about the role of Morrison, including (i) whether the determination of domesticity is material to the plaintiffs’ class claims, and (ii) if so, is that determination susceptible to generalized class-wide proof such that it represents a common, rather than an individual, question. 

The Second Circuit found that although the lower court sought to certify classes that extended as far as Morrison would allow, it failed to carefully scrutinize whether the domesticity of the debt security transactions was susceptible to class-wide proof. Under the second prong of Morrison, a plaintiff must produce evidence of, among other things, “facts concerning the formation of the contract, the placement of purchase orders, the passing of title, or the exchange of money.” While the need to show a “domestic transaction” applies equally to putative class members and may therefore present a common question, the “Plaintiffs bear the burden of showing that, more often than not, they can provide common answers.” The district court suggested that the pertinent locational details for each transaction were likely to be found in the “record[s] routinely produced by the modern financial system,” and “are likely to be documented in a form susceptible to the bureaucratic processes of determining who belongs to a Class.” This did not, however, obviate the need to consider the plaintiff specific nature of the Morrison inquiry. The district court did not consider the ways in which evidence of domesticity might vary in nature or availability across the various permutations of the transactions, including who sold the relevant securities, how the transactions were effectuated, and what forms of documents might be offered to support domesticity. Therefore, the Second Circuit vacated the class certification and directed the district court to conduct a robust predominance inquiry with respect to the domesticity of the underlying transactions. The Second Circuit’s ruling in Petrobras demonstrates that Morrison may create substantial hurdles to class certification, even after investors have sufficiently pleaded a domestic transaction under Morrison.