Investors and issuers alike should take note of the Supreme Court's opinion in Morrison v. National Australian Bank as it could have major implications for their ability to sue or be sued for securities fraud in the future.
In a ground breaking decision decided yesterday the High Court in Morrison rejected years of federal jurisprudence on the extraterritorial application of US securities fraud legislation. In a scathing opinion by Justice Scalia, the Court criticized the Second Circuit's vaunted "conduct" and "effects" test for establishing subject matter jurisdiction over foreign investors trading foreign securities on foreign exchanges (the so called "foreign cubed" case). The Court found that the authority to hear a securities fraud case involving foreign investors and securities is a question of "merit" and not a question of subject matter jurisdiction. In other words, rather than diving into the particulars of the defendant's conduct or the nationality of the parties, the Court found that the question is whether Section 10(b) gives rise to a private cause of action for securities that are traded outside of the territory of the United States.
In opposition to the Second Circuit's test involving foreign securities traded on foreign exchanges, the Court promulgated the "transactional test" for determining the extraterritorial reach of US securities fraud laws. The Court held that "[T]hose purchase-and-sale transactions are the objects of the statue's solicitude...And it is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which Section 10(b) applies."
As of today there are at least 1,028 securities class action cases that have been filed but have not yet reached a court approved settlement. Clearly, the lower courts in the days, weeks, and months to come will have their work cut out for them in applying the Court's transactional test to their pending cases. However, the lower courts may not have much deciphering to do. While the High Court's opinions have at times in other contexts been cryptic, it is hard to construe the Court's opinion in Morrison to be anything less than a clear precedent that drastically reins in the extraterritorial reach of US securities fraud laws. For example, the Court's rejection of the Second Circuit's jurisdictional analysis tends to indicate that gone are the days of considering the nationality of the plaintiff or even the nationality of the issuer. A plain reading of the opinion seems to indicate that the threshold question is whether the security in question is traded on a US stock exchange. If it is not, then the transactional rule would seem to bar suit.
It should be noted, however, that the lower courts could have trouble in determining the meaning of the second prong of the transaction test, the "domestic transactions in other securities" language. One reading of this language could be simply that the Court is referring to American Depository Receipts (ADRs). This reading would seem to make sense as it parallels the Court's dicta restricting Section 10(b) to US stock exchanges and limiting it to the territory of the US. But, the rule does not expressly mention ADRs. Therefore, a much more liberal reading of the opinion could construe the rule to, for example, provide a cause of action for the purchase of securities on a foreign exchange through the internet by a US citizen who is having coffee at the local java shop.
Even given the more liberal interpretation discussed above, it is not hard to imagine that application of the plain language of the Court's opinion to the world of US securities class actions will have far reaching implications. Below are just a few questions that come to mind.
- If the transactional rule in fact bars all standing to sue for fraud in connection with securities traded on foreign exchanges, it could have a notable impact not just on foreign investors, but also on any domestic investors who trade on foreign exchanges. Hypothetically speaking, such investors would be barred from suit in the US in connection with those foreign traded securities and would have to seek redress in a foreign country under that country's laws. Most of these countries will not have a class action framework like that in the US, if one exists at all.
- The number and size of class actions in the US may shrink if a plaintiff's foreign securities are barred from suit. For example, of the 530+ suits that settled in 2009 approximately 50 of them were against defendants domiciled in a country outside the US (9.4%). If we retroactively apply the transactional rule it is reasonable to assume that at least around 10% of the cases that were settled last year would either not have been brought in the US at all or would have been much smaller in size and scope. This is not to mention the extraction of foreign securities claims from settlements that were primarily dominated by securities traded on domestic exchanges.
- Development of class action/mass action litigation as a remedy in foreign countries may be expedited as the plantiff's bar seeks alternative forums for redress in a post global recession landscape.
- Foreign issuers may start declining registration on US stock exchanges in order to avoid costly US securities class actions.
- The opinion does not carve out an exception for the extraterritorial reach of SEC and DOJ actions. Thus, it could be construed to place the same limitations on these agencies as it does on private claimants.
- US claims administrators may start requesting verification from investors of the exchange on which their securities are traded.
The above are just some of the changes that one might anticipate as a result of the decision in Morrison. But, it should be noted that the Court's ruling was based on the absence of language in Section 10(b) that would extend its reach to foreign investors and stock exchanges. Therefore, a congressional amendment to the SEA of 1934 would render the Court's opinion moot. With the financial reform bill winding its way through Congress, proposals like Section 7216 of H.R. 4173 (extending extraterritorial reach of the SEC and DOJ) would start to rein in the Court's transactional rule. And, other legislation, such as that providing for aiding and abetting liability in securities fraud suits, as well as language adopting the Second Circuit's conduct and effects test, could also extend the reach of the statutory fraud remedy.
In any event, interest by many parties in expansion of the class action overseas will undoubtedly be sparked by the decision in Morrison. As such, it is more important than ever that investors become knowledgeable about the legal landscape for securities fraud in foreign countries. Therefore, be on the look out for a forthcoming white paper from SCAS canvasing the current securities class action landscape in Europe and in other areas of the world.
*For more colorful insight into Morrison as well as coverage on other securities related actions pending before the High Court see Keven LaCroix's D&O Diary blog entry here: http://www.dandodiary.com/2010/06/articles/securities-litigation/more-thoughts-about-morrison-v-national-australia-bank/
*The Supreme Court's decision in Morrison v. National Australia Bank can be obtained here: http://www.supremecourt.gov/opinions/09pdf/08-1191.pdf.