As the securities markets have expanded globally, investors are increasingly seeing their investments as part of a larger, international market. Foreign purchasers of securities have found the legal remedies afforded investors in American litigation an attractive alternative to their home-country systems, so that an increasing number of foreign purchasers have sought access to the US courts to redress claims relating to the securities they purchased, even when those foreign purchasers bought foreign securities on non- American exchanges. Such actions raise questions of subject matter jurisdiction: Does the US court possess the authority to resolve the claims of foreign purchasers, who may be complaining of conduct that took place principally but not exclusively outside of the United States, when those purchasers did not buy their securities in the US? This is not just an interesting legal question – foreign issuers have incurred significant costs litigating such claims in recent years.
The Second Circuit's decision in Morrison v. National Australia Bank Ltd.1 provides the most recent answer to the question of whether so-called ‘foreign-cubed’ cases are viable.2 The Morrison Court leaves open the possibility that in the proper circumstances under the established effects and conduct tests a foreign purchaser of a foreign security on a foreign exchange may be able to state a viable securities fraud claim in the United States. But Morrison suggests that in most foreign-cubed securities cases it will in fact be quite difficult for foreign plaintiffs to state a cause of action that will survive a motion to dismiss.
On October 23, 2008, the United States Court of Appeals for the Second Circuit issued its highlyanticipated decision in Morrison v. National Australia Bank Ltd. The Court held that the District Court had properly dismissed the action against National Australia Bank for lack of subject-matter jurisdiction, but declined to establish a bright-line test rejecting subject matter jurisdiction in all so-called ‘foreigncubed’ securities lawsuits.
Morrison had been closely monitored by the securities bar, and a number of private and governmental organizations, including the Washington Legal Foundation, the Association of Corporate Counsel, the U.S. Chamber of Commerce, and the Securities and Exchange Commission, submitted amicus briefs. Ultimately, the Court refused to set a bright-line rule barring foreign-cubed claims and instead adhered to and clarified the case-by-case analysis it had previously applied in Psimenos v. E.F. Hutton & Co.3 In Psimenos, the Court held that subject matter jurisdiction should depend on a ‘conduct’ and ‘effects’ test based on whether 1) the wrongful acts took place in the United States and 2) if the effects of these wrongful acts were felt in the United States. Applying that test to Morrison, the Court found that the wrongful conduct that the foreign plaintiffs complained of took place in Australia, not the United States, and therefore upheld the dismissal of the complaint.
The Case Before the Court
The three appealing plaintiffs were individuals who had purchased ordinary shares of NAB outside the United States and subsequently brought suit against NAB, NAB’s subsidiary, HomeSide Lending, Inc., and certain NAB and HomeSide executives. Plaintiffs sought to represent a class of foreign purchasers. A fourth plaintiff had purchased ADRs in the United States, but his claims were eventually dismissed for failure to prove damages. He did not appeal, so that the only appellants before the Second Circuit were purchasers who had acquired their shares abroad.
Defendant NAB is a major Australian bank that has approximately 1.5 billion shares trading on the Australian Securities Exchange, the London Stock Exchange, the Tokyo Stock Exchange and the New Zealand Stock Exchange. NAB’s ADRs trade on the New York Stock Exchange. In February 1998, NAB acquired defendant, HomeSide, an American mortgage service provider.
HomeSide accounted for approximately 5.4% and 4.1% of NAB’s total profits in 1999 and 2000 respectively. However, the valuation model that HomeSide used to calculate the present value of fees that it was to collect, was flawed, resulting in erroneous reporting to the parent company, NAB. In July 2001, NAB disclosed that it would have to write-down $450 million due to HomeSide’s miscalculations. Plaintiffs alleged that this report purportedly caused the value of NAB’s ordinary shares and its ADRs to fall 5%. In September 2001, NAB reported that it would have to write-down an additional $1.75 billion. Plaintiffs contended that NAB’s ordinary shares then fell 13% and its ADRs more than 11.5%.
The Second Circuit’s Decision
Judge Barrington D. Parker, writing for a panel that included Judges Calabresi and Newman, affirmed the District Court’s decision dismissing the complaints for lack of subject matter jurisdiction.
The Securities Exchange Act is silent as to its extraterritorial application. In determining whether to apply the securities law to foreign transactions, the Second Circuit has traditionally focused on an effects and conduct test, looking to where the conduct was perpetrated and whether there was a substantial impact in the United States.4
NAB and several of the amici argued in favor of applying a bright-line rule barring foreign-cubed lawsuits from being heard in the United States, instead of a case-by-case approach. The defendants contended that hearing foreign-cubed cases in the United States would conflict with the securities laws of other countries, where there are often greater hurdles to bringing securities class actions than exist in the United States. The Court, however, declined this invitation adhering to the Psimenos conduct and effect test, even in foreign-cubed cases. The Court noted that while certain aspects of securities laws vary widely from country to country, the laws supporting anti-fraud enforcement are generally substantively similar. Furthermore, the Court held that a bright-line restriction on foreign-cubed cases would “conflict with the goal of preventing the export of fraud from America,” and that it was “leery of rigid bright-line rules because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result in their being subject to American jurisdiction.”
The Court then analyzed whether the allegations in this particular case were sufficient to support jurisdiction under the Psimenos test. And here the Court had interesting things to say about where the “heart of the alleged fraud” took place and aiding and abetting liability generally.The foreign plaintiffs had argued that the erroneous valuations performed by HomeSide at its Florida headquarters and submitted to NAB constituted the central part of the fraud at issue.They reasoned that hadHomeSide not sent the inflated figures to NAB, no fraud to purchasers would have occurred. Defendants, on the other hand, argued that the central elements of the alleged fraud were the allegedly false and misleading statements made to the public by NAB in Australia.
The Court held that the acts and omissions by NAB in Australia were significantly more central to the fraud than the acts by HomeSide in Florida. The Court reasoned that the chain of events linking HomeSide’s erroneous reporting to the eventual communication to the public by NAB, the public parent, was too disjointed. Citing the Supreme Court’s decision in Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc.,5 it explained that “deceptive acts [that] were not communicated to the public do not suffice to show reliance . . . except in an indirect chain that we find too remote for liability.” As for the acts of HomeSide, the Court, citing the Circuit’s earlier decision in Wright v. Ernst & Young LLP,6 stated that such conduct is “merely aiding and abetting, and no matter how substantial that aid may be, it is not enough to trigger liability under Section 10(b).” According to the decision, even though HomeSide made misrepresentations to NAB, those misrepresentations were not statements to the public, and, thus, were insufficient to raise liability under Section 10(b) and, in turn, were insufficient to provide a basis for jurisdiction.7
Despite the hopes of the business community and defendants’ bar, the Second Circuit declined to set a bright-line rule rejecting jurisdiction over foreign-cubed securities lawsuits. Such lawsuits are not likely to go away soon. The recent turmoil in the credit markets may well spawn a new generation of foreign-cubed lawsuits. And, foreign investors focused on plaintiff-friendly U.S. class action procedures and damages remedies will likely continue to find the U.S. courts an attractive venue.
But Morrison’s application of the conduct and effects test indicates also that foreign plaintiffs in these cases will have a difficult burden in actually sustaining jurisdiction.The Court’s conclusions -- that the heart of the fraudulent conduct was the issuance of the allegedly misleading financial statements in Australia, even though the underlying wrongful and overstated revenues were booked at the U.S. subsidiary, and that the U.S. subsidiary’s fraudulent conduct amounted at most to aiding and abetting – together point against the likelihood of finding subject matter jurisdiction in many foreign-cubed transactions.