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F-Cubed Securities Litigation Foiled by the U.S. Supreme Court

Jun.28.2010

On June 24, 2010, the U.S. Supreme Court issued its opinion in a closely watched "F-cubed" securities action. F-cubed refers to foreign investors who buy shares of a foreign company on a foreign exchange, and then attempt to assert securities claims against that foreign company in U.S. courts. The leading case on whether U.S. courts have jurisdiction over these types of actions was Morrison v.National Australia BankLtd., 547 F.3d 167 (2d Cir. 2008). In that case, the Second Circuit affirmed dismissal of the plaintiffs' claims because the defendant's actions that directly caused the plaintiffs' losses did not occur within the United States. The U.S. Supreme Court has now affirmed that decision, but for different reasons. Five Justices joined the majority opinion, and three other Justices concurred in the judgment. (Justice Sotomayor took no part in the consideration or decision of the case, and Justices Breyer and Stevens wrote concurring opinions. In particular, Justice Stevens, joined by Justice Ginsburg, disagreed with the majority's reasoning and rejection of prior precedent.)

National Australia Bank ("NAB") is Australia's largest bank. Although it is domiciled in Australia and issued shares that are registered on the Australia, London, Tokyo, and New Zealand exchanges, NAB conducts operations in the U.S. through a Florida-based mortgage servicing company, Homeside. After announcing write-downs due to accounting irregularities at Homeside, the price of NAB's ordinary shares fell. NAB was sued in New York federal court in a consolidated class action by plaintiffs who had purchased NAB stock abroad (or American Depository Receipts representing shares of foreign stock, which are exchanged on the New York Stock Exchange). The plaintiffs alleged that NAB violated Section 10(b) of the Securities and Exchange Act of 1934 (the "Exchange Act") by making false and misleading statements concerning Homeside's operations and its contributions to NAB's financial health in, inter alia, filings with the U.S. Securities and Exchange Commission and foreign securities exchanges. This, the plaintiffs argued, led to an artificial inflation of the price of NAB's securities, which ultimately caused losses to the plaintiffs when the share price fell. The claims of the U.S. purchaser of NAB shares (the American Depository Receipts) were dismissed during an earlier phase of the case in light of his failure to plead adequately any damage caused by NAB's conduct. Therefore, when the case came before the Supreme Court, the plaintiffs consisted entirely of foreign shareholders who purchased NAB shares on foreign exchanges.

NAB moved to dismiss the action, claiming the court did not have jurisdiction because it was a foreign defendant. The Southern District of New York dismissed the case, finding that it did not have subject matter jurisdiction over plaintiffs' claims because the alleged fraud had very little, if any, effect on the U.S. market (the "effect test") and because foreign actions, not U.S. domestic actions, directly caused the alleged harm (the "conduct test"). The Second Circuit affirmed the dismissal. It rejected a bright line rule barring U.S. jurisdiction in all F-cubed securities actions. Rather, the court relied on past precedent (the effect and conduct tests) and determined that "the heart of the alleged fraud" was NAB's actions in Australia, not any actions within the U.S., given that plaintiffs' claims rested on NAB's public financial statements which were created and issued in Australia.

The U.S. Supreme Court opinion, written by Justice Scalia, affirmed the Second Circuit's decision. The Court's opinion begins by noting a "longstanding principle of American law 'that legislation of Congress . . . is meant to apply only within the territorial jurisdiction of the United States.'" Slip Op. at 5 (citation omitted). In other words, "[w]hen a statute gives no clear indication of an extraterritorial application, it has none." Id. at 6. Thus, the Court concluded that because Section 10(b) of the Exchange Act is silent regarding its extraterritorial application (which both the lower courts noted as well), it does not apply extraterritorially -- it applies only to "transactions in securities listed on domestic exchanges, and domestic [purchase and sale] transactions in other securities." Id. at 16, 18.

In reaching this conclusion, the Court criticized the Second Circuit's (and other courts') approaches to jurisdiction in these cases. First, Justice Scalia noted that courts have disregarded the presumption against extraterritoriality, and in doing so have developed tests and "vague formulations" that were "not easy to administer." Id. at 9. This, according to commentators cited by the Court, led to unpredictable and inconsistent application of Section 10(b) to transnational cases. Id. at 11. Accordingly, the Court rejected such "judicial lawmaking" in favor of a presumption against extraterritoriality. Id. at 12. The Court also rejected arguments presented by the plaintiffs (and the Solicitor General) that certain aspects of the Exchange Act do reflect an intent to apply the Act outside of the U.S. For example, although there are "general" and "fleeting" references to foreign commerce and the dissemination and quotation abroad of securities prices, these do not overcome the presumption against extraterritoriality. Id. at 13-14. Moreover, the Court noted that another section of the Exchange Act (Section 30(b)) does specifically mention extraterritorial application, and therefore concluded that such a provision "would be quite superfluous if the rest of the Exchange Act already applied to transactions on foreign exchanges." Id. at 15.

Based on this analysis, the Court affirmed dismissal of the case for failure to state a claim on which relief can be granted. The impact of the NAB decision on both publicly traded companies and their D&O insurers will be debated for years to come. However, in the immediate term, it is clear that this ruling affords some protection to foreign corporations that register shares on non-U.S. exchanges.

Click here for a copy of the Court's opinion.

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Michelle A. Jones
Counsel – Washington, D.C.
Phone: +1 202.624.2571
Email: mjones@crowell.com