While we wait to see whether the U.S. Supreme Court will grant the pending petition for a writ of certiorari in connection with the Second Circuit’s recent landmark opinion in the Morrison v, National Australia Bank case, the lower courts must continue to wrestle with questions regarding the extraterritorial application of the U.S. securities laws, particularly with respect to the claims of so-called "f-cubed" or "foreign-cubed claimants" – that is, foreign domiciled investors who bought their shares in foreign companies on foreign exchanges.
In an interesting August 13, 2009 decision in the C.P. Ships Ltd. class action securities lawsuit (here), the Eleventh Circuit distinguished the Second Circuit’s holding in Morrison and concluded that in that case the district court had properly exercised jurisdiction over the claims of the f-cubed claimants under the circumstances presented. The decision illustrates how these jurisdictional issues can arise in a surprisingly broad variety of procedural contexts and also shows how the cases continue to raise complex jurisdictional and policy concerns as well.
C.P. Ships Ltd. is a Canadian company with its headquarters in the United Kingdom that also conducts "crucial headquarters activities" (that were central to the alleged fraud) in Tampa, Florida. The company’s shares trade on the New York and Toronto Stock Exchanges.
In 2004, the company transitioned to a single accounting platform. Later, the company disclosed that the transition had caused it to understate its operational costs. The company’s share price declined and investors initiated lawsuits in the both U.S. and Canadian courts. Background regarding the U.S. action can be found here.
On April 5, 2007, the district court dismissed the U.S. securities lawsuit (refer here), and the plaintiffs appealed. While the appeal was pending, the parties agreed to settle for $1.3 million. The settlement class included claims of some foreigners but, the Eleventh Circuit stated, it "specifically excludes the claims of Canadian citizens who purchased CP stock" on the Toronto exchange.
A Canadian investor who bought his shares on the NYSE, Allen Germain, objected to the settlement on behalf of Canadian investors who, like himself, bought their shares on the NYSE, as well as on behalf of other foreign investors who purchased their shares on the Toronto exchange. Among other things, Germain asserted that the district court lacked subject matter jurisdiction over these investors’ claims. The district court overruled Germain’s objections and approved the settlement. Germain appealed.
The Eleventh Circuit’s Opinion
Even though Germain bought his shares on the NYSE and therefore lacked standing to represent the interests of foreign investors who bought their shares on the Toronto exchange, the Eleventh Circuit addressed the jurisdictional issues of both groups of foreign claimants, "because of our obligation to examine our jurisdiction sua sponte,"noting that there do not in any event appear to be many of the latter group of investors.
After observing that the ’34 Act is "silent as to its extraterritorial application," the court reviewed the two jurisdictional tests for transnational securities frauds, the "conduct" test and the "effects" test, the court concluded that the Complaint "alleges ample facts sufficient to establish subject matter jurisdiction under the ‘conduct text’ over unnamed foreign class members who purchased" their shares on the Toronto exchange, and therefore it did not need to address the "effects" test.
In arguing that the district court lacked subject matter jurisdiction over the foreign investors’ claims, Germain sought to rely on the Second Circuit’s holding in Morrison, in which the court there had found that because the principal activities supporting the alleged fraud had taken place in Australia, rather than at the company’s Florida-based subsidiary, the district court in that case lacked jurisdiction. Germain argued that the U.S.-based activities alleged in the C.P. Ships case were merely preparatory, and that the alleged misrepresentations appeared in connection with the company’s overseas release of its financial statements that were prepared overseas.
The Eleventh Circuit concluded that the Morrison case was "distinguishable," because in Morrison case, "all of the executives bearing responsibility to present accurate information to the investing public, and all the actions in supervising and verifying the information, occurred in Australia."
By contrast, in the CP Ships case, where the company’s CEO was based in Tampa, the Eleventh Circuit said "not only did the manipulation and falsification of numbers occur in Florida, the executives with responsibility for ensuring the accuracy of the accounting data operated from Florida." The court also found that the chain of causation in the CP Ships case between the conduct in the U.S. and the alleged fraud "was direct and immediate," by contrast to the Morrison case.
Based on its conclusion that the Morrison case was distinguishable due to the difference in factual allegations, the Eleventh Circuit found that the district court properly exercised subject matter jurisdiction. The court further concluded that the district court had properly overruled Germain’s objections to the settlement, and accordingly the Eleventh Circuit affirmed the district court’s approval of the settlement.
Even though the Second Circuit held there was no subject matter jurisdiction in the Morrison case itself, its holding (and in particular its rejection of the "bright line" test urged by some parties and amici) expressly recognized the possibility that under certain circumstances it would be appropriate for U.S. courts to exercise subject matter jurisdiction over the claims of "f-cubed" claimants. The CP Ships case provides an example where a court concluded that such a jurisdictional exercise is held to be appropriate.
The implication of these cases is that these jurisdictional issues are very fact dependent and must be decided on a case by case basis. By the same token, the Eleventh Circuit’s careful analysis of the difference in the allegations between the CP Ships case and the Morrison case in effect provides a road map for plaintiffs seeking to establish U.S. court jurisdiction for the claims of f-cubed claimants.
This analysis is all very pragmatic and measured, but still it arguably disregards the larger policy question of whether or to what extent U.S. courts should be implementing what is in effect the extraterritorial application of U.S. securities laws. It is worth reflecting that in addition to the U.S. court action involving CP Ships, a separate action involving the same issues was pending in Canadian courts. The Eleventh Circuit’s decision says remarkably little about the significance of this parallel proceeding and how its existence ought to affect the U.S. court’s exercise of jurisdiction over the claims of foreign claimants.
These questions about the extraterritorial application of U.S. securities laws matter, because, as analyses of the 2008 securities class action lawsuit filings all show (refer for example, here), foreign-domiciled companies increasingly are the targets of U.S. securities class action lawsuits.
Moreover, while most of these cases involve companies whose shares trade on U.S. securities exchanges, some do not. For example, EADS, whose shares do not trade on the U.S. exchanges, is the target of a U.S. securities lawsuit (about which refer here)
Indeed concerns about these extraterritoriality issues clearly have influenced at least some courts to decline to exercise jurisdiction over the claims of foreign domiciled investors (refer for example here, with regard to the case involving AstraZeneca).
Perhaps if the U.S. Supreme Court grants the writ of certiorari in the Morrison case, these larger policy concerns will be addressed.
But in the meantime the Eleventh Circuit’s opinion in the CP Ships case demonstrates that even after the Second Circuit’s ruling in Morrison, there are circumstances where courts will conclude that their exercise of subject matter jurisdiction – even with respect to the claims of f-cubed claimants – is appropriate.
This possibility creates an obvious liability concern for potentially affected companies outside the U.S. It also presents a challenge for D&O underwriters, who must factor into their risk analysis of companies outside the U.S. the possibility of those companies facing securities liability exposure under the U.S. securities laws. And as the EADS case shows, this exposure may not even be limited to companies whose shares trade on the U.S. securities exchanges – the exposure potentially could extend even to companies whose shares trade only on exchanges outside the U.S.
One thing that is clear is that in an increasingly global economy, the question of the cross-border application of domestic securities laws is a serious and growing concern.
The "Ultimate Solution" to Securities Fraud?: According to an August 6, 2009 Associated Press article entitled "China Executes Two for Defrauding Investors" (here), China executed two business people for defrauding hundreds of investors out of about $127 million, calling the scam "a serious blow to social stability."
The article reports that Du Yimin, a beauty parlor owner, collected more than $102.5 million from hundreds of investors promising them monthly returns up to ten percent, from investments in beauty parlors, real estate and mining businesses. She spent most of the money on houses, cars and luxury items. The second defendant collected $24 million from 300 investors in a separate scam by saying they could received interest up to 108 percent.
Bernard Madoff’s 150-year prison sentence looks positively restrained by comparison.
Special thanks to a loyal reader for the link to the AP story.