Securities: Morrison Requires Either Irrevocable Liability Incurred, or Title Transferred, in U.S. — Not Mere Use of U.S. Broker-Dealer — Applicability of §10(b) Goes to Merits, Not Subject Matter Jurisdiction

Absolute Activist Value Master Fund Limited v. Ficeto, 2012 U.S. App. LEXIS 4258 (2d Cir. Mar. 1, 2012):

This case requires us to determine whether foreign funds' purchases and sales of securities issued by U.S. companies brokered through a U.S. broker-dealer constitute "domestic transactions" pursuant to Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010) ("Morrison"), which held that § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") only applies to "transactions in securities listed on domestic exchanges[] and domestic transactions in other securities." Id. at 2884 (emphasis added).

Plaintiffs-appellants, nine Cayman Islands hedge funds (the "Funds"), appeal from a judgment of the United States District Court for the Southern District of New York (Daniels, J.) dismissing the complaint with prejudice. ***[W]e hold that to sufficiently allege the existence of a "domestic transaction in other securities," plaintiffs must allege facts indicating that irrevocable liability was incurred or that title was transferred within the United States. Because there has been significant ambiguity as to what constitutes a "domestic transaction in other securities," the plaintiffs should have the opportunity to assert additional facts leading to the plausible inference that either irrevocable liability was incurred or that title passed in the United States. ***

In determining whether § 10(b) and Rule 10b-5 could apply extraterritorially, this Court had previously applied the so-called conduct and effects test, which focused on: "(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 United States citizens." See SEC v. Berger, 322 F.3d 187, 192-93 (2d Cir. 2003). However, in Morrison, the Supreme Court rejected the conduct and effects test and held that § 10(b) and Rule 10b-5 do not apply extraterritorially, but only apply to "transactions in securities listed on domestic exchanges[] and domestic transactions in other securities." 130 S. Ct. at 2884.***

B. Subject Matter Jurisdiction

As an initial matter, the district court erred in dismissing the case for lack of subject matter jurisdiction because Morrison makes clear that whether § 10(b) applies to certain conduct is a "merits" question. See Morrison, 130 S. Ct. at 2877. ***

C. Domestic Purchases and Sales

1. The Meaning of a Domestic Transaction

While Morrison holds that § 10(b) can be applied to domestic purchases or sales, it provides little guidance as to what constitutes a domestic purchase or sale. To determine the meaning of a domestic purchase or sale, we first consider how these terms are defined in the Exchange Act. "The terms 'buy' and 'purchase' each include any contract to buy, purchase, or otherwise acquire." 15 U.S.C. § 78c(a)(13). Similarly, "[t]he terms 'sale' and 'sell' each include any contract to sell or otherwise dispose of." Id. § 78c(a)(14). While the Supreme Court has previously noted that these definitions "are for the most part unhelpful" because "they only declare generally that the terms 'purchase' and 'sale' shall include contracts to purchase or sell," see SEC v. Nat'l Sec., Inc., 393 U.S. 453, 466 (1969), these definitions nonetheless suggest that the act of purchasing or selling securities is the act of entering into a binding contract to purchase or sell securities. Put another way, these definitions suggest that the "purchase" and "sale" take place when the parties become bound to effectuate the transaction. ***

Given that the point at which the parties become irrevocably bound is used to determine the timing of a purchase and sale, we similarly hold that the point of irrevocable liability can be used to determine the locus of a securities purchase or sale. Thus, in order to adequately allege the existence of a domestic transaction, it is sufficient for a plaintiff to allege facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security. We note that this test has already been adopted and applied by district courts within this circuit. See SEC v. Goldman Sachs & Co., 790 F. Supp. 2d 147, 159 (S.D.N.Y. 2011); Plumbers' Union, 753 F. Supp. 2d at 177.

However, we do not believe this is the only way to locate a securities transaction. After all, a "sale" is ordinarily defined as "[t]he transfer of property or title for a price." BLACK'S LAW DICTIONARY 1454 (9th ed. 2009); see also U.C.C. § 2-106(1) ("A 'sale' consists in the passing of title from the seller to the buyer for a price."). Thus, a sale of securities can be understood to take place at the location in which title is transferred. Indeed, the Eleventh Circuit has held that, in order to survive a motion to dismiss premised on Morrison, it is sufficient for the plaintiff to allege that title to the shares was transferred within the United States. See Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, 645 F.3d 1307, 1310-11 (11th Cir. 2011) ("Given that the Supreme Court in Morrison deliberately established a bright-line test based exclusively on the location of the purchase or sale of the security, we cannot say at this stage in the proceedings that the alleged transfer of title to the shares in the United States lies beyond § 10(b)'s territorial reach."). Accordingly, to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange, we hold that a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.

We now turn briefly to the reasons we reject other potential tests proposed by the parties. Plaintiffs suggest that the location of the broker-dealer should be used to locate securities transactions. While we agree that the location of the broker could be relevant to the extent that the broker carries out tasks that irrevocably bind the parties to buy or sell securities, the location of the broker alone does not necessarily demonstrate where a contract was executed. Next, plaintiffs assert that the identity of the securities should be used to determine whether a securities transaction is domestic and that where, as in this case, the securities are issued by United States companies and are registered with the SEC, the transactions are domestic within the meaning of Morrison. However, the plaintiffs' argument is belied by the wording of the test announced in Morrison. The second prong of that test refers to "domestic transactions in other securities," Morrison, 130 S. Ct. at 2884, not "transactions in domestic securities" or "transactions in securities that are registered with the SEC." Thus, we cannot conclude that the identity of the security necessarily has any bearing on whether a purchase or sale is domestic within the meaning of Morrison.

Defendants Ficeto, Hunter, and Colin Heatherington argue that the identity of the buyer or seller should be used to determine whether a transaction is domestic. Where the buyer and seller are both foreign entities, these defendants argue that a transaction cannot be considered domestic. Under this test, the second type of transaction at issue in this case -- the transactions between and among the Funds themselves -- would not be domestic. While it may be more likely for domestic transactions to involve parties residing in the United States, "[a] purchaser's citizenship or residency does not affect where a transaction occurs; a foreign resident can make a purchase within the United States, and a United States resident can make a purchase outside the United States." Plumbers' Union, 753 F. Supp. 2d at 178.

Finally, we consider defendant Ewing's argument that despite the Supreme Court's rejection of the conduct and effects test in favor of a transactional approach, it is still necessary to determine whether each individual defendant engaged in at least some conduct in the United States. Specifically, Ewing contends that even if the U.S. Penny Stock transactions occurred in the United States, it would still be impermissible to apply § 10(b) to him since he did not personally engage in any conduct in the United States. Ewing's lack of contact with the United States may provide a basis for dismissing the case against him for lack of personal jurisdiction -- an argument the district court will consider on remand -- but the transactional test announced in Morrison does not require that each defendant alleged to be involved in a fraudulent scheme engage in conduct in the United States. Accordingly, rather than looking to the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct within the United States, we hold that a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.

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