Editor's Note: The corrected post is being republished to remedy an error in the prior email notification. The National Australia Bank case now awaiting decision before the United States Supreme Court raises what the Second Circuit in that same case called "the vexing question of the extraterritorial application of the [U.S.] securities laws." But while we all await the outcome of the NAB case, the lower courts are continuing to wrestle with these "vexing" questions. In two recent decisions in separate cases, two federal district court judges found they lacked subject matter jurisdiction over claims under the U.S. securities laws against foreign domiciled companies. Each of these decisions involved different aspects of the jurisdictional question and each represents outcomes that are interesting in distinct ways.
These questions of the extraterritorial application of the U.S. securities laws are most apparent in cases involving so-called "f-cubed claimants" – that is, foreign domiciled investors who bought their securities in foreign domiciled companies on foreign exchanges. Many of the most noteworthy recent cases, including the NAB case itself, have arising in the context of f-cubed claimant cases. The Fairfax Financial Holding case discussed below represents another example of an f-cubed claimant case.
But the European Aeronautic Defence & Space Co. case discussed below also involved a foreign domiciled company whose shares trade on foreign exchanges, but the plaintiff and the putative class consisted exclusively of U.S.-based investors. Thus, the EADS case represents an example of an "f-squared" case, as described in an April 10, 2010 memo (here) by lawyers from the Wachtell Lipton firm (who represented the EADS defendants in the EADS case) on the Harvard Law School Forum on Corporate Governance and Financial Reform. Nevertheless, though the case represented a lower jurisdictional exponent (i.e., squared rather than cubed) the court nonetheless found that it lacked subject matter jurisdiction, as discussed below.
European Aeronautic Defence & Space Co.: EADS is a public company organized under Dutch law and headquartered in the Netherlands. Its shares trade on Paris and Frankfurt stock exchanges, as well as on four Spanish exchanges. Its disclosures are governed by the laws of the European Union and its member states.
EADS shares are not traded on any U.S. exchange, although three U.S. banks have unsponsored American Depositary Receipts in EADS shares. EADS does not make filings with the SEC.
Bristol County Retirement System (a Massachusetts-based municipal employee retirement system) filed a securities complaint against EADS and three of its officers in the Southern District of New York on behalf of "all persons and entities residing in the United States" who purchased EADS shares during the class period. The complaint alleges that the defendants misled investors about production delays in the Airbus A380 super jumbo aircraft.
The defendants moved to dismiss alleging that the court lacked subject matter jurisdiction.
In a March 26, 2010 ruling (here), Southern District of New York Judge William H. Pauley III granted defendants’ motion, finding that neither the alleged U.S.-based conduct nor the alleged U.S.-based effects were sufficient to support jurisdiction.
With respect to his finding that the plaintiffs’ allegations failed to meet the conduct test, Judge Pauley said:
This was a European fraud. EADS is headquartered in Europe. Its shares trade only on European exchanges. It is subject to regulation by the European Union and its member states. Its investor disclosures were prepared and disseminated in Europe. The A380 production difficulties transpired in Europe. Bristol County purchased EADS shares on a European exchange. The gravamen of the Complaint is that EADS’s fraudulent disclosures in Europe inflated its share price on European exchanges, causing Bristol County to lose Euros. The only thing American about this case is Bristol County.
Even though Bristol sought to represent a class only of U.S. investors, Judge Pauley concluded that the plaintiffs failed to meet the effects test as well, ruling that "none of the putative class members are alleged to have acquired EADS shares on domestic securities markets." Judge Pauley added that "absent allegations linking the effects of the fraud to the United States, the federal securities laws do not reach this predominantly foreign fraud."
Interestingly, Judge Pauley found the plaintiff’s allegations did not meet the effects test despite the plaintiff’s contention that "there are seventy-three U.S. investors who hold 7 percent of EADS’s total outstanding shares," noting that these investors bought their shares overseas, and that even if some class members acquired shares as ADRs, absent a showing of a "substantial" effect on the purchasers, the "Court could not conclude the effects test has been met."
Judge Pauley also indicated that the doctrine of foreign non conveniens also separately supported dismissal, finding, among other things that the plaintiffs had an "adequate alternative forum" in European courts, notwithstanding the absence of class action procedures and the absence of recognition of the fraud on the market theory in those jurisdictions.
Fairfax Financial Holdings Limited: Fairfax is a Canadian financial holding company with a U.S.-based reinsurance operating unit. A Canadian investment fund, which bought its Fairfax shares in Canada, sued Fairfax in the Southern District of New York in a securities class action lawsuit, alleging that Fairfax had manipulated its reported financial results by improperly accounting for certain reinsurance contracts entered by its U.S.-based unit.
Though the named plaintiff bought its shares in Canada, Fairfax’s subordinate voting shares trade on the NYSE, and Fairfax has filed reports with the SEC.
In a March 29, 2010 opinion (here), Southern District of New York Judge George B. Daniels granted the defendants’ motion to dismiss for lack of subject matter jurisdiction. Judge Daniels found that "this case involves Canadian plaintiffs who bought shares of a Canadian company on a Canadian exchange" and that "neither the conduct nor the effects test provides a jurisdictional basis."
Judge Daniels found that the "allegations concerning United States based conduct are severely limited, both in number and jurisdictional significance." Though Fairfax’s U.S.-based reinsurance unit entered into the questioned transactions, the allegedly misleading financial statements were prepared in Canada. The U.S. unit’s conduct "may have contributed to the alleged scheme," but it was "Fairfax’s alleged conduct in Canada that defrauded investors and caused an inflated stock price."
Even thought the plaintiffs alleged an impact on U.S. markets and on U.S. investors, Judge Daniels found "the United States interest affected in this action is minimal, at best," particularly given that "this case involves foreign purchasers who acquired securities in a foreign exchange" and the lead plaintiff "fails to allege that any shares were bought or sold by investors on the New York Stock Exchange."
Though there are U.S. investors and though Fairfax has filed reports with the SEC, the lead plaintiff "fails to indicate that any conduct in Canada caused a United States investor to suffer a loss," and "conclusory allegations that Defendants’ fraud had a significant effect on unnamed Fairfax securities holders in the United States are insufficient."
At least at the surface level, these cases are about nothing more than what the courts found the plaintiffs failed to allege. The inference is that with different allegations, the cases might have been permitted to proceed.
As a different level, however, these cases may be more about an unstated but evident judicial reluctance to impose U.S. securities laws on foreign companies in connection with securities transactions that took place outside the U.S. Because there is (at least not yet) no definitive legal authority that U.S. courts lack jurisdiction over extraterritorial transactions involving non-U.S. companies (whether or not the claimant is based in the U.S.), these courts both described their rulings in terms of the insufficiency of the plaintiffs’ allegations. However, in neither case were plaintiffs allowed to amend in order to attempt to cure the pleading defects.
Where you come out on the question whether or not these cases were correctly decided may well depend on how you feel about allowing U.S. courts to entertain cases under the U.S. securities laws against foreign domiciled companies, particularly with respect to transactions that took place outside the U.S. The plaintiffs in these cases may well feel aggrieved that a case, on the one hand, on behalf of exclusively U.S.-based investors, and, on the other hand, on against a company whose shares trade on U.S. exchanges and which files reports with the SEC, were not permitted to proceed in U.S. courts.
Defense-inclined observers may feel these courts appropriately declined jurisdiction. These observers may well contend that the mere presence of U.S-based investors alone without more arguably should not be enough to support jurisdiction, for the simple reason that there are very few investment vehicles of any kind any where in the world that do not have some U.S. investor involvement. If the mere presence of U.S. investors alone were sufficient to support jurisdiction, there would be few companies or transactions beyond the potential liability reach of the U.S. securities laws.
There is, however, a larger question here, which is whether U.S. securities laws appropriate should ever be applied to impose potential liability on non-U.S. companies and corporate officials in connection with transactions that took place outside the U.S. It might fairly be argued that to apply U.S.-based liability principles in this context might be an inappropriate extraterritorial extension of U.S. law to persons and transactions more appropriately regulated by the laws of other jurisdictions. One might argue that principles of comity and judicial restraint weigh against the U.S. courts’ exercise of jurisdiction.
The NAB base now awaiting decision at the U.S. Supreme Court may well address these larger principles, although the requirements of the specific case before the court may lead the court to rule narrowly, for example, declining jurisdiction without saying more about the circumstances under which jurisdiction is appropriate and how principles of comity might weigh in the analysis. These cases do raise difficult questions of legal authority and reach in a complex global economy.
As the cases above demonstrate, these issues will continue to arise, and absent definitive guidance from the Supreme Court – or Congress – the lower courts will continue to sort their way through these issues.
Andrew Longstreth’s March 31, 2010 AmLaw Litigation Daily article about these two cases can be found here. The 10b-5 Daily’s post about the EADS case can be found here. My initial post about the EADS case at the time the case was first filed can be found here.
Justice Stevens: The papers this weekend are full of articles about the retirement of Justice John Paul Stevens and his possible replacement. Perhaps in anticipation of these events, a couple weeks ago the New Yorker ran a March 22, 2010 biographical sketch of Stevens (here) written by the journalist and Court observer, Jeffrey Toobin. The article draws an interesting portrait of Stevens as the last of a dying breed, the moderate Republican. I recommend the article. It conveys a strong sense of the role that Stevens has played on the Court, particularly in recent years, as well as the possible consequences his departure may have going forward.
Advisen Quarterly Securities Litigation Webinar: On Friday April 16, 2010, I will be participating in an Advisen webinar, entitled "First Quarter Securities Litigation Review," to discuss first quarter 2010 securities lawsuit filings as well as other first quarter securities litigation developments. Other participants in the webinar, which will take place at 11:00 am EDT, include Ken Ross from Willis, ACE’s Scott Meyer, Wilkie Farr’s Michael Young, and Advisen’s David Bradford. Advisen’s Jim Blinn will moderate. Registration information for the webinar can be found here.