Jump to Navigation | Jump to Content
American Bar Association

U.S. Jurisdiction Over Foreign-Cubed Securities Transactions

By Stewart D. Aaron and Lauren R. Bittman

On October 15, 2009, U.S. Congressman Paul Kanjorski, a subcommittee chair on the House Financial Services Committee, introduced the Investor Protection Act of 2009 (the Investor Protection Act). H.R. 3817, 111th Cong. (1st Sess. 2009). As proposed, the Investor Protection Act, among other things, would attempt to clarify the extraterritorial reach of the anti-fraud provisions of the U.S. securities laws. The Federal securities laws have always been silent on the extraterritorial reach of their provisions. Because of this, U.S. courts have struggled to determine when it is proper to assert jurisdiction over securities transactions that take place outside of the United States. Two recent court cases, in the U.S. Court of Appeals for the Second Circuit and the Eleventh Circuit, respectively, highlight this struggle. These decisions involved so-called "foreign-cubed" securities transactions-transactions where a foreign plaintiff is suing a foreign issuer in a U.S. court for violations of U.S. securities laws based on securities transactions in foreign countries. While the courts used much of the same reasoning, the particular facts of each case led the courts to opposite conclusions in determining whether the court should assert jurisdiction. Although the proposed Investor Protection Act, if adopted, would not provide a bright-line rule to determine when U.S. jurisdiction is appropriate, it does appear to codify certain analyses used by the Second and Eleventh Circuits.

Second Circuit Approach
In October 2008, in Morrison v. National Australia Bank Ltd., the Second Circuit left open the possibility for class actions involving "foreign-cubed" securities transactions to be brought in Federal courts in the Second Circuit. 547 F.3d 167 (2d Cir. 2008). In refusing to adopt a bright-line rule that barred these types of suits, the court cited the shared goal of governments around the world to combat securities fraud. The court determined that the decision of whether subject matter jurisdiction exists should continue to be made on a case-by-case basis. The Second Circuit nevertheless affirmed the dismissal of the suit at issue for lack of subject matter jurisdiction, concluding that the "heart of the fraud" lay outside of the United States.

In Morrison, three individuals who purchased shares of National Australia Bank (NAB) abroad sought to bring a class action against NAB and a U.S. subsidiary of NAB, HomeSide Lending Inc. (HomeSide), along with individual officers and directors in the United States District Court for the Southern District of New York, alleging violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 10b-5 promulgated thereunder. (A fourth U.S. plaintiff who purchased NAB American Depository Receipts [ADRs], sought to represent a class of U.S. purchasers. The district court dismissed the U.S. plaintiff's claims due to his failure to allege that he suffered damages from the alleged fraud. On appeal, plaintiffs focused exclusively on the claims of the non-U.S. plaintiffs and did not challenge the dismissal of the U.S. plaintiff's claims.)

The plaintiffs alleged that HomeSide knowingly used unreasonable valuation assumptions or methodologies, and that certain defendants made materially false and misleading statements in NAB's SEC filings, annual reports and press releases regarding HomeSide's profitability, economic health, and its contribution to NAB. The plaintiffs claimed that HomeSide falsified the data in the United States and then sent the data to NAB headquarters in Australia where NAB personnel disseminated it via public filings and statements. As a result, NAB's shares, which did not trade on U.S. exchanges, dropped in value. The district court dismissed the plaintiffs' claims for lack of subject matter jurisdiction and the Second Circuit reviewed the matter on appeal.

When determining the extraterritorial reach of Section 10(b) of the Exchange Act, the Second Circuit has looked to whether the harm was perpetrated in the United States or abroad and whether it affected domestic markets and investors, referred to, respectively, as the "conduct test" and the "effects test." Where appropriate, the two tests were applied together in order to give a more complete picture of whether there was sufficient U.S. involvement to justify the exercise of jurisdiction by a U.S. court. Under the conduct and effects test, the court asks (1) whether the wrongful conduct occurred in the United States; and (2) whether the wrongful conduct had a substantial effect in the United States or upon U.S. citizens. Jurisdiction exists under the conduct test when "substantial acts in furtherance of the fraud were committed within the United States."

According to the Second Circuit, subject matter jurisdiction would exist over the plaintiffs' claims if NAB's conduct in the United States was "more than merely preparatory to a fraud," and "culpable acts or omissions" occurring within the United States directly caused losses to the non-U.S. investors. Because the Exchange Act does not address its extraterritorial application, the Second Circuit inferred that Congress would have wanted to "redress harms perpetrated abroad which have a substantial impact on investors or markets within the United States." The Second Circuit also reasoned that declining jurisdiction over all foreign-cubed securities fraud actions would conflict with the goal of "preventing the export of fraud from the United States."

In order for the Second Circuit to determine whether it had subject matter jurisdiction in Morrison, it had to determine whether the alleged misconduct that occurred in the United States was "merely preparatory" or comprised the "heart of the alleged fraud." HomeSide had allegedly manipulated its internal books and records in the United States and sent the falsely inflated numbers to NAB's headquarters in Australia. NAB, operating from Australia, then created and distributed its public filings and related public statement from Australia. Based on these facts, the Second Circuit affirmed the District Court's decision that it lacked subject matter jurisdiction because the allegedly improper actions and failures to act by NAB in Australia were significantly more central to the fraud, and more directly responsible for the harm to investors, than the purported manipulation of the data in the United States. NAB, not HomeSide, was the publicly traded company and NAB's executives, assisted by its lawyers, accountants and bankers, had primary responsibility for the corporation's public filings, for its relations with investors and for its statements to the public.

In addition, the Second Circuit noted the absence of any allegation that the alleged fraud affected U.S. investors or the U.S. capital markets. Plaintiffs did not contend that what was allegedly done had any meaningful effect on U.S. investors or its capital markets. The Second Circuit also noted the lengthy chain of causation between the U.S. contribution to the misstatements and the harm to investors. It was alleged that HomeSide sent falsified data to NAB in Australia; it was not alleged, however, that HomeSide sent any incorrect data directly to investors. The Second Circuit reasoned that if NAB's corporate headquarters had monitored the accuracy of HomeSide's data before transmitting it to investors, the data would have been corrected without investors suffering any harm. The Second Circuit concluded that while HomeSide's purported manipulation of the data may have contributed to the misinformation, a number of significant events occurred before this misinformation caused losses to investors.

Because the allegedly fraudulent statements emanated from corporate headquarters outside of the United States, there was little, if any, effect on the United States or U.S. citizens, and because there was a lengthy chain of causation between the U.S. subsidiary's actions and the statements that reached investors, the Second Circuit ultimately affirmed the district court's decision that subject matter jurisdiction did not exist in Morrison. However, the Second Circuit left open the possibility that in different circumstances, a non-U.S. plaintiff could file suit in a U.S. court against a non-U.S. issuer of securities for violations of U.S. securities laws based on transactions outside of the United States.

The plaintiffs in Morrison have since appealed the case to the U.S. Supreme Court. In June 2009, in connection with the pending petition for a writ of certiorari, the U.S. Supreme Court entered an order asking the Office of the Solicitor General to express the views of the United States. The Solicitor General responded with a brief filed on October 27, 2009, in favor of denying the petition for a writ of certiorari. The Solicitor General stated that "although the courts of appeals have not been entirely uniform in their analysis of Section 10(b)'s application to transnational frauds, petitioners cite no decision indicating that another circuit would have allowed their suit to proceed." The Solicitor General also cited to the proposed Investor Protection Act, in noting that the possibility that Congress may soon address the extraterritorial scope of the Federal securities laws provides an additional reason for the U.S. Supreme Court to deny the petition. However, despite the Solicitor General's position, on November 30, 2009, the U.S. Supreme Court granted plaintiffs' petition for certiorari.

Eleventh Circuit approach
In August 2009, questions were raised again as to the extraterritorial reach of the U.S. courts in securities transactions outside of the United States when the Eleventh Circuit in In Re: CP Ships Ltd. Securities Litigation distinguished the case from the Second Circuit's decision in Morrison. 578 F.3d 1306 (11th Cir. 2009). The Eleventh Circuit held that the U.S. district court properly exercised subject matter jurisdiction over securities fraud claims brought by foreign investors against CP Ships, a Canadian company that was headquartered in England. Although CP Ships is a non-U.S. company, with headquarters outside of the U.S., the complaint alleged that an accounting consolidation of CP Ships business was being run by key CP Ships executives out of its Florida office. It was alleged that this consolidation caused executives to knowingly understate costs. Executives in the Florida office were alleged to have transmitted the false data to CP Ships' foreign offices, where it was incorporated into false and misleading financial statements that were disseminated from abroad.

Similar to the approach taken by the Second Circuit in Morrison, the Eleventh Circuit stated that, when a court is confronted with a transaction that is predominantly foreign, it should determine whether Congress would have wanted the resources of U.S. courts and law enforcement agencies to be used on it, rather than leaving the problem to foreign countries. In making this determination, the Eleventh Circuit reviewed the conduct test and the effects test that were also relied upon in Morrison. The court concluded that because the complaint alleged ample facts sufficient to establish subject matter jurisdiction under the conduct test, it did not need to address the effects test.

The Eleventh Circuit reasoned that the conduct test was satisfied because the manipulation and falsification of the accounting data occurred in the United States and the executives with responsibility for ensuring the accuracy of the accounting data operated from the United States as well. The court distinguished these facts from the facts of Morrison, in which the manipulation of the data occurred in the United States, but the executives bearing responsibility to present accurate information to the investment public and their actions in supervising and verifying such information were located in Australia. In contrast to Morrison, the Eleventh Circuit determined that, in CP Ships, there was no "lengthy chain of causation" between the United States' contribution to the misstatements and the harm to investors, noting that the "causation was direct and immediate."

Looking forward
As evidenced by the decisions in the Second and Eleventh Circuits, jurisdictional issues that arise in transnational securities fraud cases tend to be very fact specific. In addition, because Congress has been silent on the proper scope of the U.S. securities laws, courts have been forced to speculate when Congress would want U.S. courts to assert jurisdiction over foreign securities transactions.

Congress may yet step into the fray. The Investor Protection Act, as proposed, attempts to clarify these issues and outlines the jurisdictional reach of the U.S. Securities Act of 1933, as amended, the Exchange Act, and the Investment Advisers Act of 1940. The proposed extraterritorial reach of the statutes is very broad and seems to essentially codify the conduct test and the effects test discussed by the Second and Eleventh Circuits. Section 215 of the proposed Investor Protection Act amends the Federal securities laws to specify that U.S. courts can exercise jurisdiction in any action involving "conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well as "conduct occurring outside the United States that has a foreseeable substantial effect within the United States."

However, because Section 215 of the proposed Investor Protection Act has not yet been adopted and is only one aspect of the wide sweeping reform that has been proposed under the Investor Protection Act, it is unclear whether the jurisdictional language will survive the legislative process.

If Congress does not act, then the securities litigation bar will eagerly await the U.S. Supreme Court's decision in the Morrison case. Regardless of the legal principles that eventually are established, one can expect that the outcome of jurisdictional issues facing foreign litigants will continue to be based on a fact intensive analysis.

Parts of this article, written by the authors, appeared in pieces published previously by Arnold & Porter LLP.

Copyright © 2017, American Bar Association. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association, the Section of Litigation, this committee, or the employer(s) of the author(s).

Back to Top