October 29, 2008
On October 23, 2008, the United States Court of Appeals for the Second Circuit issued a published and precedential decision in Morrison v. National Australia Bank (Docket Number 07-0583-cv), which left open the door for applications of the anti-fraud provisions of American securities laws in so-called "Foreign-Cubed" securities cases–that is, cases brought by foreign plaintiffs, against a foreign company, arising out of a foreign securities transaction. Although the Court declined to exercise jurisdiction because of the particular facts of the National Australia Bank case, the Court also declined to adopt a bright-line rule barring jurisdiction in all such cases.
Facts and Procedural Posture of National Australia Bank
National Australia Bank ("NAB") is Australia’s largest bank. Its shares are traded on the Australian Securities Exchange and several other foreign exchanges; ADRs for the company are traded on NYSE. In 1998, NAB acquired an American mortgage company, HomeSide, that was the sixth largest servicer of American mortgages. HomeSide had been allegedly using incorrect accounting practices that led to an overstatement of the value of its assets. Because NAB’s securities disclosures reflected asset valuations that incorporated the HomeSide numbers, the problems with HomeSide’s accounting practices led to an overstatement of the value of NAB’s assets as well. In 2001, NAB announced a write down of its assets and thereafter, the value of NAB’s shares fell precipitously.
Four Plaintiffs sued NAB in the Southern District of New York, attempting to bring a class action under various anti-fraud securities provisions–among them, Rule 10(b) and 20(a) of the Securities Exchange Act of 1934 ("the Act"), and SEC Rule 10b-5.
Three of the four Plaintiffs sought to represent a class of non-American purchasers of NAB common shares, which traded on the foreign exchanges. Although the remaining Plaintiff had purchased ADRs on the NYSE and sought to represent a class of American investors, the Second Circuit’s decision focused solely on the issues involved with the foreign Plaintiffs’ claims. The foreign Plaintiffs’ claim is known as a "foreign-cubed" claim because of its three non-American dimensions: (i) the Plaintiffs are foreign, (ii) the Defendant is a foreign issuer, and (iii) the underlying securities transactions occurred abroad.
Complexities in Applying Securities and Exchange Act to Foreign-Cubed Claims
Foreign-cubed claims raise significant, and heretofore unresolved, issues of subject matter jurisdiction–that is, issues as to whether the Act’s anti-fraud provisions can be applied in these circumstances in American courts. The Securities Exchange Act does not explicitly speak to the Act’s application to foreign transactions. Courts have previously held that where a securities claim involves a foreign element, the Act should apply whenever necessary to "redress harms perpetrated abroad which have a substantial impact on investors or markets within the United States." Nat’l Austl. Bank Ltd., 2008 U.S. App. LEXIS 21986, at *10 (quotation omitted). In making that determination, courts have traditionally employed the well-known "conduct and effects" test, looking to (i) whether the allegedly fraudulent conduct occurred in the U.S., and (ii) whether it had a substantial effect in the U.S.
The foreign Plaintiffs in National Australia Bank attempted to satisfy this subject matter jurisdiction standard by focusing solely on the conduct component of this test. They claimed, in short, that the alleged HomeSide/NAB fraud resulted primarily from activities in the U.S. Specifically, the Plaintiffs alleged that HomeSide’s accounting was manipulated in Florida, that the resulting numbers were then sent from Florida to NAB’s headquarters in Australia, and that those numbers ultimately became the source of the fraud that was perpetrated abroad with the dissemination of NAB’s various financial disclosures.
Second Circuit Holds That Foreign-Cubed Claims Should Be Evaluated by the Same Standards Used for All Securities Claims
Although this was the first foreign-cubed case to reach the Second Circuit, the Court held that "the usual rules still apply." Id. at *14. Subject matter jurisdiction, the Court of Appeals explained, still depends on the extent of the American conduct and American effects. Id. With respect to the conduct inquiry, moreover, the Court made clear that subject matter jurisdiction exists only "if activities in this country were more than merely preparatory to a fraud" and "culpable acts or omissions occurring here directly caused losses to investors abroad." Id. (quoting Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir. 1991)).
Importantly, in reaffirming the "usual rules," the Second Circuit rejected the possibility of a wholesale bar to application of American anti-fraud laws to foreign-cubed claims. NAB and various amici curiae had argued for such a ban, claiming that the normal conduct and effects test should not control and suggesting instead that the Court should simply adopt a bright-line rule barring all foreign-cubed actions as too tenuously connected to the U.S. (absent significant domestic effects). NAB cautioned that anything other than a bright-line bar on foreign-cubed suits would create conflicts between American securities laws and foreign regimes, which generally erect greater barriers to prosecuting fraud class actions. The Court, however, rebuffed that argument, finding that any "potential conflict between our anti-fraud laws and those of foreign nations does not require the jettisoning of our conducts and effects test." Id. at *22. The Court reasoned that (i) foreign jurisdictions would appreciate the anti-fraud efforts of American courts, (ii) that the Act means to prevent all parties–foreign and domestic–from staging frauds from the United States, and (iii) that this purpose can best be furthered by allowing for jurisdiction even in foreign-cubed cases.
Despite leaving the door open for jurisdiction in foreign-cubed cases, the Second Circuit ultimately declined to exercise jurisdiction over the particular fraud alleged in the National Australia Bank case itself. "The actions taken and the actions not taken by NAB in Australia," the Court concluded, "were . . . significantly more central to the fraud and more directly responsible for the harm to investors than the manipulation of the numbers in Florida." Id. at *25. The Court emphasized that the fraudulent misstatements alleged by the Plaintiffs flowed from the vetting and incorporation of the HomeSide numbers into the NAB financial disclosures–activities that took place at NAB’s corporate headquarters in Australia–and not from the mere preparation of those numbers in the United States. Id. at *26. It went on to note that a "lengthy chain of causation" thus separated the alleged American contribution from the ultimate fraud. Id. at *28. The Court also stressed the absence of any allegation of "any meaningful effect on America’s investors or its capital markets," noting that the appeal had been pressed solely on behalf of the foreign Plaintiffs. Id. at *27. "[W]e are an American court, not the world’s court," it stated in sum, and "we cannot and should not expend our resources resolving cases that do not affect Americans or involve fraud emanating from America." Id. at *24.
Implications of National Australia Bank
The implications of the National Australia Bank decision are twofold. First, while the Second Circuit affirmed the dismissal of the foreign investors securities fraud case against the foreign issuer on the facts presented, the Court made clear that federal district courts can exercise subject matter jurisdiction in foreign-cubed cases where the right mix of circumstances exists. Foreign-cubed lawsuits thus are unlikely to disappear completely anytime soon. Second, in leaving the door open to those suits but dismissing the suit against NAB, the Court at least hinted at the kind of circumstances that would make a finding of subject matter jurisdiction more likely. For instance, the Court noted that a "much stronger case" for a finding of subject matter jurisdiction would exist "where the American subsidiary of a foreign corporation issues fraudulent statements or pronouncements from the United States impacting the value of securities trading on foreign exchanges." Id. at *23-24 (emphasis added). That statement, along with the factors to which the Court pointed in declining to find jurisdiction in the particular case–including, among other things, the locus of the "heart" of the fraud, the attenuated chain of causation linking it to any activities in America, and the absence of any American effects–provide at least some guidance on the types of cases which might cause foreign issuers some concern. Foreign-cubed litigation is not gone for good. But when cases are brought, district courts likely will exercise jurisdiction only under more limited circumstances, and foreign issuers will have more arguments available for dismissal.
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