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You are an institutional investor, and as part of your most basic investment strategy you regularly invest in foreign securities to help achieve a diversified investment portfolio. Sometimes your American-based broker goes through the New York Stock Exchange, and sometimes your broker reaches out to foreign exchanges—the world is, after all, flat. But what if something went wrong with your foreign investment and you wanted to seek redress for what you found out to be an underlying fraud. Could you? If a foreign company perpetrates fraud through its American subsidiary, or if you simply acquired your security on a foreign exchange, the answer is probably no. In fact, in today’s world, because of the United States Supreme Court’s decision in the case Morrison v. National Australia Bank, you may not be able to simply file a lawsuit in federal court.
In Morrison, the Supreme Court essentially put an end to U.S.-based litigation of cases that involve securities bought and sold on foreign exchanges. Morrison’s implications are also much further reaching than just the so-called “foreign-cubed” class actions specifically underlying the decision. As new cases move through the system and policies and other global factors shift, courts and litigants continue to try to determine the boundaries of the Morrison decision. This means that any and all institutional investors who invest in foreign securities or purchase through foreign exchanges should be aware of the potential implications of the decision when entering foreign markets.
The Case and Reactions
In Morrison v. National Australia Bank, the Supreme Court decided that manipulative or deceptive conduct in connection with the purchase or sale of securities abroad is not protected by U.S. securities laws. The Court held that there was “no affirmative indication in the Exchange Act that §10(b) applies extraterritorially,” and therefore United States securities law applies only to “the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869, 2883, 2888 (2010).
The Court’s decision addressed uncertainty within the federal appellate circuit regarding whether the Securities Exchange Act applied to foreign transactions. A number of courts, particularly the Second Circuit (as happened in this case), had developed and utilized the so-called “conduct and effects tests” which examined 1) “whether the wrongful conduct had a substantial effect in the United States or upon United States citizens” (the effects test), and 2) “whether the wrongful conduct occurred in the United States” (conduct test).[i] In Morrison, the Supreme Court noted that such a test lacked any “textual or extratextual basis” and it instead shifted to a so-called “transactional test.”[ii] Specifically, the Court focused on the fact that the conduct and effects test was not reflected in the Exchange Act, was therefore against the presumption against extraterritoriality, and was developed to “resolve matters of policy”—something the Court roundly rejected as creating unpredictable and inconsistent application of §10(b).[iii] The Court firmly stated: “The results of judicial-speculation-made-law—divining what Congress would have wanted if it had thought of the situation before the court—demonstrate the wisdom of the presumption against extraterritoriality.”[iv]
The underlying case in the Morrison decision involved a so-called “foreign-cubed” class action—a class action on behalf of foreign investors who had acquired the common stock of a foreign corporation through purchases effected on a foreign securities exchange. Specifically, Plaintiffs had acquired National Australia Bank’s (“NAB’s”) common stock on the Australian Securities Exchange. Their claims involved allegedly false and misleading statements made to class members about the profitability of one of NAB’s wholly-owned subsidiaries—a United States Corporation. Plaintiffs alleged that the subsidiary’s United States-based executives overstated the company’s value and then NAB used that value in its financials; the Plaintiffs then sued under Section 10(b) of the Securities Exchange Act of 1934 and corresponding Rule 10b-5. The Court affirmed the lower courts’ dismissal of this case because the Exchange Act could not apply when the securities purchased were not listed on a U.S. exchange and when “all aspects of the purchases complained of by [the] petitioners . . . occurred outside the United States.”[v]
Proponents of the Morrison decision hailed it as providing clarity for foreign companies engaging in activities in the United States, and for curbing the alleged onslaught of oftentimes unmeritorious securities litigation in the Unites States as a result of such far-reaching and broad securities laws. However, within a month of Morrison, in recognition of some of the limits of the decision, Congress responded by partially reversing the decision through a Section of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”) which gave the SEC and DOJ authority to bring certain enforcement actions involving foreign securities, and using the “old” conducts and effects test. Specifically, this new Section of Dodd-Frank provided the district courts of the United States with jurisdiction over SEC and DOJ enforcement actions where fraud involves:
(1) conduct within the United States that constitutes a significant step in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.[vi]
In addition to disagreement over the success of the Morrison decision, Courts have continued to try to ascertain how far reaching the decision in fact is. Some of the current implications of the decision as worked out in practice and through lower court decisions to date are examined briefly below.
The Legal and Practical Implications
Purchase through a foreign exchange trumps other factors
The Morrison result can be looked at in terms of two types of transactions: 1) those relating to the purchase or sale of a security listed on an American stock exchange, and 2) those relating to the purchase or sale of any other security in the United States. It is important for institutional investors to understand the implications of both, but this section will focus only on the “listed on an American stock exchange” requirement.
First, courts have essentially blocked suit for any scenario where the security is purchased on a foreign exchange. For example, an investor in a cross-listed security will not have a Section 10(b) claim, even though the foreign issuer tends to benefit from the investor confidence that can be gained from cross-listing. Similarly, at least one court has held that the purchase of an American Depository Receipt7[vii] (“ADR”) through the over-the-counter-market does not qualify as “being listed on an American stock exchange” for the purposes of Morrison. Finally, even where a transaction is initiated in the United States, for example, where a broker-dealer or investment adviser perpetrates fraud from the United States, if the transaction is through a foreign exchange, Morrison holds that Section 10(b) cannot apply.
Thus, investors need to have a deep understanding of where their final transactions are executed and should use that information when deciding just how “far away” they want to invest.
Foreign Courts, State Courts and Arbitration
Once an investment has been executed on a foreign exchange, then institutional investors must know their options. Perhaps the most profound effect of the Morrison decision for any intuitional investor in foreign securities is the need to prepare for and understand alternate venues for litigation.
First, international arbitrations are becoming increasingly common and, in fact, increasingly favored, in cross-border disputes. But international arbitrations are different from U.S.-based litigation and will change the strategy of any investor and their counsel when it comes to seeking remedies for fraud. (See “Trial Tactics in International Arbitrations: Proceedings are Fast-Paced and Compressed,” by Robins, Kaplan, Miller & Ciresi L.L.P. attorneys Jan M. Conlin and Thomas C. Mahlum for information on what to expect in international arbitrations.)
Second, where the parties have not signed agreements to arbitrate or otherwise do not agree to arbitrate, investors may find themselves in need of foreign counsel and litigating in systems that vastly differ from the United States’ litigation system—this may include less protection for investors or procedural differences like condensed discovery.
Finally, as we have seen time and time again with shifts in U.S. securities law, when barriers are created for wronged plaintiffs who would normally seek redress in federal court, they often turn to state court. Morrison-like cases have already started to filter into state courts, and in many cases, those courts are declining to dismiss them. Investors may want to consider state-based securities claims, but should prepare for differences often encountered in state courts such as prolonged litigation processes, less-sophisticated juries, and different procedural mechanisms.
Class actions in this area are seriously limited and coalitions are king
Finally, securities class actions have been robust in the United States like nowhere else. Morrison has and will limit the ability of any investor to join in a 10b-5 class action for a broad-based securities fraud scheme with foreign elements as we had seen so often before the decision. For example, in the suit Rosenbaum Partners, et al. v. Vivendi Universal, S.A., et al., investors from all over the globe, including the U.S., brought a class action based on false and misleading statements made by Vivendi to its shareholders and others about the company’s health and liquidity. After the Morrison decision, claims in the Vivendi case were dismissed despite a jury verdict in favor of Plaintiffs. This result shows that investors may have to look to forming small but powerful coalitions with other institutional investors when they are wronged by fraudulent foreign schemes rather than relying on the class-action mechanism.
The effects of Morrison are far reaching. Simply being uncertain about whether a broker ultimately executes your securities transactions on a U.S. or foreign exchange could dramatically impact the recourse available to any institutional investor when wronged. Investors need to understand the reach of Morrison and its impact on legal options so as not to unwittingly give up remedies with respect to their foreign investments. Specifically, investors need to educate themselves about alternate means of recourse such as international arbitration or “coalition-based” suits.
[vi] Sec. 929Y of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010)
[vii] An ADR is a negotiable security that represents an ownership interest in a specified number of shares in a foreign company and is traded on a U.S. exchange
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