Second Circuit Holds That the Supreme Court’s Decision in Morrison May Limit Section 10(b) Claims in U.S. Relating to U.S. Transactions Involving Primarily Foreign Securities and Foreign Issuers

August 25, 2014

On August 15, 2014, the U.S. Court of Appeals for the Second Circuit issued a ruling limiting the extraterritorial application of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") in the wake of the Supreme Court’s landmark opinion in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010).  In Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings SE, the Second Circuit held that a group of hedge funds that had entered into derivative transactions in the United States tied to the stock of a foreign issuer listed only on foreign exchanges could not bring a Section 10(b) suit against a foreign company for alleged fraudulent statements that it made primarily abroad relating to the foreign issuer.  2014 WL 3973877 (2d Cir. Aug. 15, 2014).

In Morrison, the Supreme Court ruled that Section 10(b) only provided a cause of action arising out of "[1] transactions in securities listed on domestic exchanges, and [2] domestic transactions in other securities."  Morrison v. Nat’l Austr. Bank Ltd., 561 U.S. 247, 267 (2010).  In Porsche, the plaintiff  hedge funds argued that the securities-based swap agreements ("Swaps") that they entered into in the United States, which were economically equivalent to short sales of Volkswagen AG ("VW") stock listed on foreign exchanges, constituted "domestic transactions" under Morrison, such that they could bring a Section 10(b) action in the United States against German corporation Porsche Automobil Holding SE ("Porsche") and its executives relating to allegedly fraudulent statements that Porsche had made regarding its intentions with respect to VW stock.

Although acknowledging that the Swaps may have qualified as domestic transactions under Morrison and the Second Circuit’s decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012), outlining what constituted a domestic transaction, the Second Circuit ruled in Porsche that, "while [Morrison] unmistakably made a domestic securities transaction (or transaction in a domestically listed security) necessary to a properly domestic invocation of § 10(b), such a transaction is not alone sufficient to state a properly domestic claim under the statute."  2014 WL 3973877 at *14 (emphasis added).  According to the Second Circuit, where the claims "are so predominantly foreign as to be impermissibly extraterritorial" and likely to "place § 10(b) in conflict with the regulatory laws of other nations," then, based on "the principles underlying the Supreme Court’s decision in Morrison," plaintiffs may not bring a Section 10(b) claim even if it relates to a domestic transaction.  Id. at *14, 16.  If a domestic transaction were alone sufficient to bring a Section 10(b) claim, the court observed, then the U.S. securities laws would apply extraterritorially to "allegedly fraudulent conduct anywhere in the world" so long as a derivate transaction relating to the underlying foreign securities was entered into in the United States, even where the foreign defendants were unaware of the derivative transaction.  Id. at *14.  Uncomfortable with that possibility, and noting that the allegations in Porsche related to predominantly foreign activity, the Second Circuit held that the fact that the Swap transactions were consummated in the United States was insufficient under Morrison to state a Section 10(b) claim and therefore affirmed dismissal of the complaints.  See id. at *14, 17.

The Second Circuit’s explicit rejection of any "bright-line" test of extraterritoriality — and a focus on a more overall factual circumstances approach — may well provide an argument for defendants that the Morrison extraterritoriality test can limit plaintiffs’ ability to bring Section 10(b) claims relating to transactions executed in the United States involving foreign conduct and foreign issuers, at least in the context of derivative transactions like the Swaps at issue in Porsche.  This important decision, though, contained a number of caveats that parties asserting Section 10(b) claims will no doubt focus on.  The court expressly noted that "[o]ur decision … in no way forecloses the application of § 10(b) to govern fraud in connection with … [domestic] swap agreements and where defendants are alleged to have sufficiently subjected themselves to the statute" and later noted the difficulty in providing "a rule that will properly apply . . .  Morrison . . . [to] swap agreements in particular or [] more conventional securities generally."  Id at *16.  The court even recognized in a footnote that "in many instances, especially where the parties to the suit were the parties to the transaction, the fact that the transaction was domestic might well be deemed sufficient to compel the conclusion that the invocation of § 10(b) is also domestic."  Id. at *15 n.12.

Given the Second Circuit’s move away from a bright-line test and its focus on factual circumstances, we expect to see district courts in the Second Circuit (and perhaps district and appellate courts in other circuits) take a much more fact-based approach to the issue of the extraterritoriality of Section 10(b) going forward.  This area of the law warrants careful attention as it evolves.

Gibson, Dunn & Crutcher LLP   

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments.  Please contact the Gibson Dunn lawyer with whom you usually work, or any of the following members of the Securities Litigation Practice Group Steering Committee:

Jonathan C. Dickey – Co-Chair, New York/Palo Alto (212-351-2399, 650-849-5370, jdickey@gibsondunn.com)
Robert F. Serio – Co-Chair, New York (212-351-3917, rserio@gibsondunn.com)
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George H. Brown – Palo Alto (650-849-5339, gbrown@gibsondunn.com)
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Lee G. Dunst - New York (212-351-3824, ldunst@gibsondunn.com)
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Barry R. Goldsmith – New York (212-351-2440, bgoldsmith@gibsondunn.com)
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Monica K. Loseman
– Denver (303-298-5784, mloseman@gibsondunn.com)
Brian M. Lutz – San Francisco (212-351-3881, blutz@gibsondunn.com)
Jason J. Mendro – Washington, D.C. (202-887-3726, jmendro@gibsondunn.com)
Wayne Smith – Orange County (949-451-4108, wsmith@gibsondunn.com)
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Aric H. Wu – New York (212-351-3820, awu@gibsondunn.com) 

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