Securities — Satisfaction of Morrison’s 2-Part Test Is Necessary, But Not Sufficient, to Support Invocation of 10b-5 — If Application of 10b-5 Would Be Incompatible with Foreign Regulation, 10b-5 Inapt
Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings, SE, 2014 U.S. App. LEXIS 15758 (2d Cir. Aug. 15, 2014):
In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court established that, by virtue of the presumption against extraterritorial application of U.S. statutes, § 10(b) of the Securities Exchange Act of 1934, the basic antifraud provision of the U.S. securities laws, has no extraterritorial application, and no civil suit under that section may be brought unless predicated on a purchase or sale of a security listed on a domestic exchange or on a domestic purchase or sale of another security. See id. at 267 ("And it is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies."). In Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012), this Court set forth the means to be used to determine when a transaction in securities is "domestic" such that it may furnish the basis for a suit under that section. We concluded that in order for such a transaction to qualify as domestic, "the parties [must] incur irrevocable liability to carry out the transaction within the United States or . . . title [to the securities must be] passed within the United States." Id. at 69.
In this case, the securities transactions upon which the plaintiffs brought suit were so-called "securities-based swap agreements" relating to the stock of Volkswagen AG ("VW"), a German corporation; the amount of gain and loss in the transactions depended on prices of VW stock recorded on foreign exchanges. The parties accused of fraud are Porsche Automobil Holding SE ("Porsche"), also a major German corporation, and its executives. Their allegedly fraudulent statements consisted of assertions about Porsche's intentions with respect to the stock of VW; their statements were made primarily in Germany, but were also accessible in the United States and were repeated here by the defendants. The thorny issue presented by this appeal is how to apply the rules established by the Morrison and Absolute Activist decisions to this case.
The plaintiffs, more than thirty international hedge funds, employed securities-based swap agreements pegged to the price of VW shares, which trade on European stock exchanges, to bet that VW stock would decline in value. The positions they took through their swap agreements were roughly economically equivalent to short positions in VW stock, in that they would gain to the extent VW stock declined in value and would lose to the extent it rose. Plaintiffs allege that, in 2008, defendants made various fraudulent statements and took various manipulative actions to deny and conceal Porsche's intention to take over VW. The plaintiffs allege that they relied on defendants' fraudulent denial of Porsche's intention to take over VW in making their swap agreements. When, in October 2008, Porsche made its true intentions public, the price of VW shares rose dramatically, causing the plaintiffs to suffer large losses.
The plaintiffs brought the instant complaints in the United States District Court for the Southern District of New York against Porsche and two of its corporate officers alleging, among other things, that the defendants' fraudulent statements and manipulative actions violated U.S. securities laws. Following the Supreme Court's decision in Morrison, the defendants moved to dismiss the complaint because the plaintiffs' swap agreements referenced securities trading on foreign exchanges. The district court (Harold Baer, Jr., Judge) granted the defendants' motion, concluding that the swaps were essentially transactions in securities on foreign exchanges.
We affirm the judgment, although on the basis of different reasoning. In our view, the imposition of liability under § 10(b) on these foreign defendants with no alleged involvement in plaintiffs' transactions, on the basis of the defendants' largely foreign conduct, for losses incurred by the plaintiffs in securities-based swap agreements based on the price movements of foreign securities would constitute an impermissibly extraterritorial extension of the statute. Our ultimate conclusion that this suit seeks impermissibly to extend § 10(b) extraterritorially depends in some part on the particular character of the unusual security at issue. For reasons explained below, we express no view whether we would have reached the same result if the suit were based on different transactions. Out of an abundance of caution, however, we remand the matter to the district court so that it may consider motions, if any, by one or more of the plaintiffs to amend their complaints in response to our decision on this appeal.
I. Liability for Foreign Conduct Under the Federal Securities Laws
A. The Antifraud Provision of the Exchange Act
B. Applicability in Cases Involving Extraterritorial Conduct: Morrison and Absolute Activist
Morrison and Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012) ("Absolute Activist"), comprise the principal case authority in this Circuit governing the application of § 10(b) and Rule 10b-5 to claims involving extraterritorial conduct.
1. Morrison. In the Supreme Court's 2010 opinion in Morrison, the plaintiffs alleged that National Australia Bank ("NAB"), an Australian corporation, misrepresented the value of assets held by one of its U.S. subsidiaries. Its allegedly fraudulent valuations had originated in the statements of the U.S. subsidiary. Morrison, 561 U.S. at 251-53. The plaintiffs, Australian nationals who had purchased shares of NAB on Australian exchanges, brought an action against NAB in the Southern District of New York alleging violations of § 10(b) and Rule 10b-5. Id. at 252-53. NAB moved to dismiss the complaint. Applying the so-called "conduct-and-effects test," the district court granted the motion. We affirmed because "[t]he acts performed in the United States did not 'comprise the heart of the alleged fraud.'" Id. at 253 (quoting Morrison Ct. App., 547 F.3d at 175-76) (brackets omitted).
The Supreme Court began by asserting the "longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States." Morrison, 561 U.S. at 255 (internal quotation marks omitted) (quoting EEOC v. Arabian Am. Oil Co., 499 U.S. 244, 248 (1991) ("Aramco")). This "canon of [statutory] construction," which the Court had previously labeled "the presumption against extraterritoriality," see Aramco, 499 U.S. at 248, is based on the assumption that "Congress ordinarily legislates with respect to domestic, not foreign matters." Morrison, 561 U.S. at 255. Under this presumption, "[w]hen a statute gives no clear indication of an extraterritorial application, it has none." Id. Applying the presumption to § 10(b), the Court observed that "[o]n its face, § 10(b) contains nothing to suggest it applies abroad." Id. at 262. Nor did the statute's "general reference to foreign commerce in the definition of 'interstate commerce' . . . defeat the presumption against extraterritoriality." Id. at 263. Thus finding "no affirmative indication in the Exchange Act that § 10(b) applies extraterritorially," the Court "conclude[d] that it does not." Id. at 265.
The Court criticized our Circuit's use of the conduct-and-effects test for its disregard of the presumption against extraterritoriality, further criticizing the test as unpredictable and difficult to administer. Id. at 257-59. Rejection of the conduct-and-effects test did not end the inquiry. The Court acknowledged that the "presumption here (as often) [was] not self-evidently dispositive, [and] its application require[d] further analysis." Id. at 266. In response to the plaintiffs' emphasis on the fact that NAB's allegedly false statements had originated in the United States, the Court observed that it would be "a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States," and added that "the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case." Id. (emphasis in original). The Court went on to consider what it referred to as the "'focus' of congressional concern" expressed by the statute. Id. (quoting Aramco, 499 U.S. at 255).
[T]he focus of the Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States. Section 10(b) does not punish deceptive conduct, but only deceptive conduct "in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered." 15 U.S.C. § 78j(b). Those purchase-and-sale transactions are the objects of the statute's solicitude. . . . [I]t is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies.
Morrison, 561 U.S. at 266-67 (citation omitted; emphasis added). "With regard to securities not registered on domestic exchanges," the Court concluded, the statute's "exclusive focus [is] on domestic purchases and sales." Id. at 268 (emphases in original). "Not deception alone, but deception with respect to certain purchases or sales is necessary for a violation of the statute." Id. at 272.
The Court also "reject[ed] the notion that the Exchange Act reaches conduct in this country affecting exchanges or transactions abroad" because "[t]he probability of incompatibility with the applicable laws of other countries is so obvious that if Congress intended such foreign application 'it would have addressed the subject of conflicts with foreign laws and procedures.'" Id. at 269 (quoting Aramco, 499 U.S. at 256). The Court observed that securities "regulation[s] of other countries often differ from ours as to what constitutes fraud, what disclosures must be made, what damages are recoverable, . . . and many other matters." Id. And it predicted that "[t]he transactional test we have adopted--whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange"--would avoid "the interference with foreign securities regulation that application of § 10(b) abroad would produce." Id. at 269-70.
Under Morrison, then, "[s]ection 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with 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."11 Id. at 273. Because that case "involve[d] no securities listed on a domestic exchange, and all aspects of the purchases complained of by [the plaintiffs] . . . occurred outside the United States," the Court affirmed the dismissal of the complaint. Id.
11 In response to Morrison, Congress amended the securities acts to provide that
[t]he district courts of the United States . . . shall have jurisdiction of an action or proceeding brought or instituted by the Commission or the United States alleging a violation of the antifraud provisions of this chapter involving-- (1) conduct within the United States that constitutes significant steps 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.
15 U.S.C. § 78aa(b); id. § 77v(c) (extending jurisdiction of suits brought under § 17(a) of the Securities Act of 1933 in the same fashion). The import of this amendment is unclear, however, because Morrison itself explicitly held that the Court there had jurisdiction to decide the case under the version of § 78aa then in force, even if the presumption against extraterritoriality meant that the plaintiffs failed on the merits. See Morrison v. Nat'l Austl. Bank Ltd., 561 U.S. 247, 253-54 (2010).
2. Absolute Activist. After Morrison, but while the instant appeal was pending, this Court decided Absolute Activist. That appeal required us to "determine under what circumstances the purchase or sale of a security that is not listed on a domestic exchange should be considered 'domestic' within the meaning of Morrison." Absolute Activist, 677 F.3d at 66-67. The plaintiffs, nine Cayman Islands-based hedge funds, bought shares in companies incorporated in the United States, whose shares traded only over-the-counter, directly from those companies. Id. at 63. The district court dismissed the complaint on the grounds that the allegations, including the foreign identity of the purchasers, did not state a domestic claim in light of Morrison. Id. at 65.
On appeal, we concluded 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." Id. at 69. Therefore,
in order to adequately allege the existence of a domestic transaction [under Morrison], 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.
Id. at 68. Alternatively, we held that "it is sufficient for the plaintiff to allege that title to the shares was transferred within the United States." Id. (citing and quoting Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, 645 F.3d 1307, 1310-11 (11th Cir. 2011)).
Because the complaint in Absolute Activist contained only conclusory allegations as to where liability became irrevocable or title changed hands, we remanded with instructions to the district court to allow the plaintiffs leave to amend. Id. at 69-71.
In reaching these conclusions, we rejected the plaintiffs' argument that "the identity of the securities should be used to determine whether a securities transaction is domestic and that where, as in th[at] case, the securities [were] issued by United States companies and [were] registered with the SEC, the transactions [were] domestic within the meaning of Morrison." Id. at 68. That argument was "belied by the wording of the test announced in Morrison" because "[t]he second prong of that test refers to 'domestic transactions in other securities,' not 'transactions in domestic securities' or 'transactions in securities that are registered with the SEC.'" Id. at 68-69 (citation omitted). We could not therefore "conclude that the identity of the security necessarily has any bearing on whether a purchase or sale is domestic within the meaning of Morrison." Id. at 69.
We also rejected proposed tests that would have looked to the identity of the buyer and seller, the identity of the broker, or whether, in addition to a domestic transaction, some fraudulent acts occurred in the United States, reasoning that "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." Id. at 68-69.
As a matter of first principles, the Supreme Court has said that it is "acutely aware . . . that [it] sit[s] to decide concrete cases and not abstract propositions of law" and has therefore "decline[d] to lay down . . . broad rule[s] . . . to govern all conceivable future questions in [an] area." Upjohn Co. v. United States, 449 U.S. 383, 386 (1981); see also New York v. United States, 326 U.S. 572, 575 (1946) ("One of the greatest sources of strength of our law is that it adjudicates concrete cases and does not pronounce principles in the abstract."); United States v. Blackburn, 461 F.3d 259, 262 n.2 (2d Cir. 2006) (stating that we are "empowered to decide concrete cases and not abstract principles"). One of the principal "distinction[s] between courts and legislatures [is that] the former usually act retrospectively, settling disputes between persons, [while] the latter usually act prospectively, setting the general rules for future conduct." Simmons v. Lockhart, 931 F.2d 1226, 1230 (8th Cir. 1991).
We are of course bound by Morrison and Absolute Activist in determining whether § 10(b), and Rule 10b-5 promulgated by the Securities and Exchange Commission pursuant thereto, applies to the defendants' alleged conduct. We must proceed cautiously in applying teachings the Morrison Court developed in a case involving conventional purchases and sales of stock to derivative securities, like securities-based swap agreements, that vest parties with rights to payments based on changes in the value of a stock.
A question of potentially determinative importance for this case is whether, under Morrison, a domestic transaction in a security (or a transaction in a domestically listed security)--in addition to being a necessary element of a domestic § 10(b) claim--is also sufficient to make a particular invocation of § 10(b) appropriately domestic. If a domestic transaction in a security is not only necessary but also sufficient to justify the application of § 10(b) to otherwise foreign facts, and the plaintiffs' securities-based swap agreements (which we assume for these purposes were executed and performed in the United States) are deemed domestic transactions under Absolute Activist, then all other questions would drop away. The mere fact that the plaintiffs based their suit on a domestic transaction would make § 10(b) applicable to allegedly fraudulent conduct anywhere in the world. In such a case, these complaints would properly invoke a domestic application of § 10(b).
Morrison established two important rules about the applicability of § 10(b). First, Morrison held that, because Congress did not indicate an intention that § 10(b) should apply extraterritorially, the presumption against extraterritoriality dictates that § 10(b) has no extraterritorial application. Morrison, 561 U.S. at 265. Second, Morrison ruled that § 10(b) does not apply unless the suit is predicated on either a domestic securities transaction or a transaction in a domestically listed security. Id. at 267. Because neither was present in the case before it, the Court held that the invocation of § 10(b) was impermissibly extraterritorial, and the complaint failed to state a valid claim.
On careful consideration of Morrison's words and arguments as applied to the facts of this case, we conclude that, while that case 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. We reach this conclusion for several reasons.
First, and most important, the Court did not say that such a transaction was sufficient to make the statute applicable. The language the Court used was consistent with the description of necessary elements rather than sufficient conditions. See id. at 267 ("And it is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies." (emphasis added)). The Court never said that an application of § 10(b) will be deemed domestic whenever such a transaction is present.
Second, a rule making the statute applicable whenever the plaintiff's suit is predicated on a domestic transaction, regardless of the foreignness of the facts constituting the defendant's alleged violation, would seriously undermine Morrison's insistence that § 10(b) has no extraterritorial application. It would require courts to apply the statute to wholly foreign activity clearly subject to regulation by foreign authorities solely because a plaintiff in the United States made a domestic transaction, even if the foreign defendants were completely unaware of it. Such a rule would inevitably place § 10(b) in conflict with the regulatory laws of other nations.
The principal reason that the Court "reject[ed] the notion that the Exchange Act reaches conduct in this country affecting exchanges or transactions abroad," id. at 269, was not that Congress lacked the power to do so. Indeed, the Court implied the contrary. See id. at 255 (explaining that the presumption is not a "limit upon Congress's power to legislate"). But "[t]he probability of incompatibility with the applicable laws of other countries [in the case of transfers of shares of common stock] is so obvious that if Congress intended such foreign application it would have addressed the subject of conflicts with foreign laws and procedures" in the statute. Id. at 269 (citation and internal quotation marks omitted). The Court apparently thought that, if an extraterritorial application of federal law would likely be incompatible with foreign law, and that application was intended by Congress, Congress would have addressed the conflict. The corollary of that proposition is that if an application of the law would obviously be incompatible with foreign regulation, and Congress has not addressed that conflict, the application is one which Congress did not intend.
Applying that axiom to this case illustrates the problem with treating the location of a transaction as the definitive factor in the extraterritoriality inquiry. If the domestic execution of the plaintiffs' agreements could alone suffice to invoke § 10(b) liability with respect to the defendants' alleged conduct in this case, then it would subject to U.S. securities laws conduct that occurred in a foreign country, concerning securities in a foreign company, traded entirely on foreign exchanges, in the absence of any congressional provision addressing the incompatibility of U.S. and foreign law nearly certain to arise. That is a result Morrison plainly did not contemplate and that the Court's reasoning does not, we think, permit.
For all these reasons, we conclude that, while a domestic transaction or listing is necessary to state a claim under § 10(b), a finding that these transactions were domestic would not suffice to compel the conclusion that the plaintiffs' invocation of § 10(b) was appropriately domestic.12
12 We recognize 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.
* * *
Because, in the case of securities not listed on domestic exchanges, a domestic transaction is necessary but not necessarily sufficient to make § 10(b) applicable, we need not decide whether the plaintiffs' transactions satisfy the standards of Absolute Activist for domestic transactions, because we think it clear that the claims in this case are so predominantly foreign as to be impermissibly extraterritorial.
To begin with, the application of § 10(b) to the defendants would so obviously implicate the incompatibility of U.S. and foreign laws that Congress could not have intended it sub silentio. Cf. Morrison, 561 U.S. at 269 ("[I]f Congress intended such foreign application it would have addressed the subject of conflicts with foreign laws and procedures." (internal quotation marks omitted)). The complaints concern statements made primarily in Germany with respect to stock in a German company traded only on exchanges in Europe. Were this suit allowed to proceed as pleaded, it would permit the plaintiffs, by virtue of an agreement independent from the reference securities, to hale the European participants in the market for German stocks into U.S. courts and subject them to U.S. securities laws. The potential for regulatory and legal overlap and conflict would have been obvious to any legislator who considered the possibility that the statute would result in such an application. Indeed, the fraudulent acts alleged in the complaint have been the subject of investigation by German regulatory authorities and adjudication in German courts. Although we recognize that the plaintiffs allege that the false statements may have been intended to deceive investors worldwide, we think that the relevant actions in this case are so predominantly German as to compel the conclusion that the complaints fail to invoke § 10(b) in a manner consistent with the presumption against extraterritoriality. Morrison, 561 U.S. at 266. The complaints thus fail to state a claim upon which relief may be granted.
In concluding that these complaints do not state a claim upon which relief may be granted, we do not suggest that the presence of some foreign element in a transaction necessarily means that Congress did not intend to include it in the coverage of § 10(b). To borrow Morrison's metaphor as to the effect of a minor domestic element on the nature of an overwhelmingly foreign transaction: Section 10(b) would indeed be a craven watchdog against securities fraud if it retreated to its kennel whenever a fraud involved some foreign activity.13 The potential for incompatibility between U.S. and foreign law is just one form of evidence that a particular application of a statute is extraterritorial. It is neither a safe harbor nor the only relevant consideration in the extraterritoriality analysis. It predominates in this case because of the dominance of the foreign elements we have outlined above.
13 "For it is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States. But the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case." Morrison, 561 U.S. at 266.
Our decision today in no way forecloses the application of § 10(b) to govern fraud in connection with transactions in securities-based swap agreements where the transactions are domestic and where the defendants are alleged to have sufficiently subjected themselves to the statute.
The conclusion we have reached on these facts cannot, of course, be perfunctorily applied to other cases based on the perceived similarity of a few facts. In a world of easy and rapid transnational communication and financial innovation, transactions in novel financial instruments--which market participants can freely invent to serve the market's needs of the moment--can come in innumerable forms of which we are unaware and which we cannot possibly foresee. We do not purport to proffer a test that will reliably determine when a particular invocation of § 10(b) will be deemed appropriately domestic or impermissibly extraterritorial. We believe courts must carefully make their way with careful attention to the facts of each case and to combinations of facts that have proved determinative in prior cases, so as eventually to develop a reasonable and consistent governing body of law on this elusive question. We have neither the expertise nor the evidence to allow us to lay down, in the context of the single case before us, a rule that will properly apply the principles of Morrison to every future § 10(b) action involving the regulation of securities-based swap agreements in particular or of more conventional securities generally. Neither do we see anything in Morrison that requires us to adopt a "bright-line" test of extraterritoriality when deciding every § 10(b) case. While over time a series of judicial opinions may collectively result in one or more such standards, we do not think it appropriate in this case of first impression to attempt to set forth a comprehensive rule or set of rules that will govern all future cases to come before this Court. Perhaps, in the final analysis, Congress and the Securities and Exchange Commission might be in a better position to craft broader rules in this area in light of their access to hearings, including the testimony of experts, their competence to make policy decisions, and their constitutionally and statutorily ordained roles as makers of law and rules.14 It is enough to say that we think our decision in this case is compelled by the text of the Exchange Act and the principles underlying the Supreme Court's decision in Morrison, as applied to our facts.
14 Congress directed the Securities and Exchange Commission to carry out a study "to determine the extent to which private rights of action under the antifraud provisions of the Securities and Exchange Act of 1934 . . . should be extended to cover" domestic conduct in connection with foreign transactions or foreign conduct with domestic effects. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 929Y, 124 Stat 1376, 1871 (2010). But that study, released in April 2012, offered only general options without advocating for any particular approach, further underscoring the complexity of these matters. See SEC Staff, Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934 (2012), available at http://www.sec.gov/news/studies/2012/929y-study-cross-border-private-rights.pdf.
We therefore affirm the district court's dismissal of the complaints. Recognizing, however, that our decisions here and in Absolute Activist have elaborated on the standards set forth in Morrison in such a way that the plaintiffs might conceivably be able to draft amended complaints that would invoke a domestic application of § 10(b), we remand to allow the district court to entertain a motion to amend the complaints.
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