United States: Supreme Court Closes Door to Foreign-Cubed Securities Lawsuits in U.S. Courts

In a significant, recent ruling, the Supreme Court held in Morrison v. National Australia Bank, Ltd.¹ that the U.S. securities laws do not extend to so-called "foreign-cubed" securities lawsuits. A "foreign-cubed" lawsuit is a securities claim brought by (1) foreign purchasers of securities against (2) foreign issuers for violations of American securities laws concerning (3) securities that are traded on foreign stock exchanges. The decision has global implications for foreign investors and foreign financial institutions and may effectively bar claims not "transacted" in the United States from U.S. securities laws.

The recent tumult felt in the world's financial markets has prompted investors worldwide to search for favorable forums, such as the U.S. courts, in which to bring securities claims. Foreign plaintiffs in classaction securities suits have not only been able to bring suit against foreign financial firms in U.S. courts, but have also managed to secure significant settlements and even verdicts against these foreign issuers.

In National Australia Bank, Australian plaintiffs, who had bought ordinary shares of National Australia Bank, in Australia, brought a Rule 10b-5 claim against NAB for alleged misstatements made in the U.S., relating to the value of NAB's U.S. mortgage business subsidiary, HomeSide Lending, Inc.² For years, courts have struggled with the issue of how to handle lawsuits relating to foreign companies such as National Australia Bank, which are filed under Section 10(b) of the Securities Exchange Act and Rule 10b-5 implementing it. This is because the Securities Exchange Act is silent as to its extraterritorial effect. Prior to National Australia Bank, U.S. courts applied a "conduct and effects" test to determine whether certain alleged violations fall within the restrictions of the Securities Exchange Act, assessing each claim on a case by case basis. This method of construing the Securities Exchange Act was judicially created and its application varied from circuit to circuit, creating a precarious environment for many foreign financial institutions, or conversely, as the Court put it, a "Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets."

The decision of the Supreme Court, written by Justice Scalia, effectively ends any uncertainty, coming down against extraterritorial application of the Act. The Court held that when there is no "affirmative indication" that a statute applies extraterritorially, a court should not interpret it to have that effect. In other words, a presumption against extraterritoriality exists. Applying this presumption to Section 10(b), the Court held that the statute "contains nothing to suggest it applies abroad" and held that it indeed did not have extraterritorial effect.

Having clearly established that the Securities Exchange Act is presumed to not have extraterritorial application, the Court also delineated which securities claims can be categorized as extraterritorial in nature. The Court adopted a "transaction" test to determine when a purchase or sale is extraterritorial under Rule 10b-5, rather than a "conduct and effects" test. Instead of examining where a supposed fraud was perpetrated and where the effects of such fraud would be felt, the court must look to where the actual transaction for the purchase or sale of securities took place. Accordingly, the Court held that Section 10(b) only applies to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities."

The National Australia Bank plaintiffs clearly failed to pass muster under the Court's "transaction" test, because they had purchased their securities on foreign stock exchanges. In effect, the Court's decision renders all "foreign-cubed" lawsuits barred from U.S. courts. While this is a blow to the securities class-action plaintiffs bar, it is undoubtedly a relief for the many foreign financial institutions who were faced with the prospect of defending suits in the U.S. courts, where the securities laws often conflict with those of the issuer's home governments. It remains to be seen how the "transaction" test will be applied to the numerous variations in securities transactions that will undoubtedly emerge in the near future.

Foreign financial firms will not necessarily be immune from securities fraud claims in U.S. courts. Foreign issuers of both ordinary stock as well as ADRs that are purchased or sold on U.S. stock exchanges will continue to be subject to the Securities Exchange Act with respect to such purchasers or sellers. Moreover, National Australia Bank essentially construed the reach of Section 10(b) as a matter of statutory interpretation. It remains available to Congress to attempt to extend that reach. The financial regulatory reform bill currently before Congress provides that in regulatory actions brought by the Department of Justice or the Securities and Exchange Commission, U.S. courts shall have jurisdiction in any action alleging a violation of the antifraud provisions of the securities laws involving:

Additionally, if passed, this bill would require the SEC to conduct a study to ascertain whether Congress should enact legislation that would grant a private right of action under the "conduct and effects" test, potentially overturning the Court's decision in National Australia Bank. Accordingly, we may see additional developments in this area.

Footnotes

1 559 U.S. __ (2010). 1

2 In November, 2008, we explained in our Litigation Alert, "The Second Circuit Court of Appeals Declines the Invitation to Establish a Bright-Line Rule Barring Foreign-Cubed Securities Lawsuits," that while dismissing the case, the Second Circuit declined to apply a bright-line rule to "foreign-cubed" lawsuits. The Supreme Court granted review and numerous amici including the Solicitor General and the governments of various nations, whose financial institutions were being subjected to U.S. securities laws, submitted briefs in the case.

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