In its June 2010 decision in the Morrison v. National Australia Bank, the U.S. Supreme Court enunciated a "transactions" test to determine the applicability of the U.S. securities laws. The Court said that the U.S. securities laws apply only to "transactions in securities listed on domestic exchanges and domestic transactoins in other securities." Subsequent courts have wrestled with the second prong as they struggled to determine what constitutes a "domestic transaction in other securities."
In a March 1, 2012 opinion (here), the Second Circuit in the Absolute Activist Value Master Fund Limited v. Ficeto case for the first time examined the requirements under Morrison’s second prong, holding that in order to establish the existence of a domestic transaction in other securities, a plaintiff “must allege facts suggesting that either irrevocable liability was incurred or title transferred within the United States.” The opinion helpfully suggests the kinds of allegations that would satisfy this test, and also clarifies that certain allegations that are not relevant in determining whether or not this standard has been satisfied.
The plaintiffs in this case are nine Cayman Island hedge funds (the “Funds”) that invested on behalf of hundreds of investors around the world, including also U.S. investors. In 2004, the Funds engaged Absolute Capital Management Holdings Limited (“ACM”) to act as investment manager. The complaint alleges that various individual ACM officers and employees engaged in a “pump and dump scheme,” using in part a California broker-dealer in which several of the individual defendants had ownership interests. (The SEC’s related February 25, 2011 enforcement action against many of the same individuals can be found here.)
The plaintiffs allege that the defendants caused the Funds to purchase billions of shares of thinly capitalized U.S. companies. All of these companies were incorporated in the U.S. and their shares were quoted on the OTC BB or on Pink Sheets. However, the Funds’ shares in these companies were purchased directly from the companies themselves in private offerings in the form of private investment in public equity transactions (“PIPE” transactions).
The plaintiffs allege that the defendants used transactions to and between the Funds to generate commissions and to inflate the prices of the companies’ shares. The plaintiffs further allege that after the companies’ share prices were inflated, the individual defendants unloaded their personal holdings in the companies’ securities for a substantial profit. The Funds allegedly suffered losses of over $195 million.
The Funds filed suit against certain ACM officers and employees, as well as against the California brokerage and its principles. The defendants moved to dismiss. The district court dismissed the case on the basis of Morrison, and the plaintiffs appealed.
The March 1 Decision
Apparently because the securities the Funds had purchased were procured by Cayman Island hedge funds through PIPE offerings, the parties did not argue and the Second Circuit did not address whether or not the plaintiffs allegations satisfies Morrison’s first prong relating to “transactions in securities listed on domestic exchanges.” The Second Circuit addressed only Morrison’s second prong, attempting 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.” The Court noted in that regard that Morrison itself “provides little guidance as to what constitutes a domestic purchase or sale.”
Examining prior decisions addressing the question of what determines the timing of a purchase or sale, the Second Circuit said that “given that the point at which the parties become irrevocably bound is used to determine the timing of a purchase or sale, we similarly hold that the point of irrevocable liability can be used to determine the locus of a purchase or sale.” In order for a plaintiff to allege sufficient facts to support a plausible inference that the parties incurred irrevocable liability within the United States, the plaintiffs must allege 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.”
The Second Circuit went on, in recognition of the Eleventh Circuit’s June 2011 decision in the Quail Cruise Ship Management case also interpreting Morrison’s second prong (about which refer here, scroll down), to note that “a sale of securities can be understood to take place at the location at which title is transferred.”
Combining these two tests, the Second Circuit concluded that “to sufficiently allege a domestic transaction in securities not listed on a domestic exchange, we hold that a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.”
Having thus enunciated what is required in order to satisfy Morrison’s second prong, the Second Circuit proceeded to reject other tests the parties had proposed. In particular, the Second Circuit said the location of a broker-dealer alone should not be used to determine the location of a securities transaction (although the location of a broker could be relevant to the extent the broker carries out tasks that irrevocably bind the parties to buy or sell securities).
The Second Circuit also rejected the argument that the identify of the securities themselves could be used to determine whether a transaction is domestic, even if the securities are issued by United State companies and are registered with the SEC. The Second Circuit said that it “cannot conclude that the identity of the securities necessarily has any bearing on whether a purchase or sale is domestic.”
Similarly, the Court held that the identity of the buyer or seller alone is not determinative of the issue whether a transaction is domestic. Even if both the buyer and the seller are both foreign, that alone would not resolve the question of whether or not a transaction is domestic. The Second Circuit also rejected the argument that the Court must determine with respect to each defendant whether that defendant engaged in at least some conduct in the United States, noting that the transaction test does not require each defendant alleged to be involved in the fraudulent scheme to have engaged in conduct in the United States.
In summing up its rulings, the Second Circuit said that “rather than looking to the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct within the United States, we hold 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 with the United States.”
Having determined the standard to be applied, the Second Circuit held that the allegations of the plaintiffs in this case were not sufficient to establish that the transactions at issuer were “domestic” and therefore subject to the U.S. securities laws -- which is hardly surprising given that the plaintiffs had framed their allegations before the U.S. Supreme Court issued its Morrison decision. The Second Circuit held that the case should be remanded to the district court so that the plaintiffs could attempt to amend their pleading to try to address Morrison’s requirements. The Second Circuit specifically said that the kinds of allegations to be included to establish that the transactions at issue were domestic include “facts concerning the formation of the contracts, the placement of the purchase orders, the passing of title, [and] the exchange of money.”
Prior to the Second Circuit’s ruling in this case, and In trying to flesh out what makes a transaction “domestic” under Morrison’s second prong, the courts had worked out two competing standards. The first of these standards, enunciated in June 2011 by Southern District of New York Judge Barbara Jones in the SEC v. Goldman Sachs case, held that the place of the transaction is determined based upon the place where” irrevocable liability” is incurred (as discussed here). An alternative interpretation of the standard was described in the Eleventh Circuit’s 2011 opinion in the Quail Cruise Ship Management case (about which refer here, scroll down), in which place of the location of the transfer of title could be sufficient to establish that a transaction was domestic. (Judge Jones, in reliance of the District Court opinion in the Quail Cruise Ship Management case, had held that the place of the closing alone was insufficient to determine whether or not a transaction was domestic.)
Rather than chose between these two potentially competing lines of analysis for determining under Morrison’s second prong whether or not a transaction is domestic, the Second Circuit simply incorporated both, holding that facts suggesting either that irrevocable liability was incurred in the United States or that title was transferred in the United States were sufficient to establish that a transaction was “domestic.”
By affirming both tests, the Second Circuit arguably broadened the circumstances that could be sufficient to satisfy Morrison’s second prong. On the other hand, by stating firmly the kinds of things that would not be sufficient (such as the identity of the buyers or sellers and the identity of the securities), the Second Circuit arguably restricted the circumstnaces under which plaintiffs may be able to argue that a transaction is domestic. Finally, by enumerating the kinds of issues the plaintiffs should attempt to address (such as the facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money), the Second Circuit provided at least some guidance of the kinds of things plaintiffs should include in their allegations in order to try to satisfy Morrison’s second prong.
Even in the short amount of time since the U.S. Supreme Court issued the Morrison opinion, a considerable number of disputes had arisen in which plaintiffs asserting claims under the U.S. securities laws had tried to rely on Morrison’s second prong in order to establish that the U.S. securities laws apply to the non-market transaction that is the basis of their claim. The Second Circuit’s opinion could have a significant impact on these non-market transaction cases, especially those pending in the Second Circuit.
Among other cases that would seem to be significantly affected by the Second Circuit’s opinion in this case is the appeal in the Porsche case now pending in the Second Circuit. As noted here, in December 2010, Southern District of New York Judge Harold Baer had held in the Porsche case that a swap transaction could not come within Morrison’s second prong where the referenced security traded on a non-U.S. exchange. The Second Circuit’s holding in the Absolute Activist Value Master Fund Limited case, in which the Second Circuit said among other things that the identify of the securities involved in the transaction is not determinative, would seem to suggest that the district court’s holding in the Porsche case may not withstand scrutiny on appeal.
Although it remains to be seen, the Second Circuit’s ruling in the Absolute Activist Value Master Fund Limited case could expand the number of types of cases in which plaintiffs seeking to assert securities claims involving non-market trades may be able to survive a motion to dismiss made in reliance on the Morrison decision.
A March 2, 2011 memo by the Cahill law firm about the Second Circuit's opinion can be found here. A March 2, 2012 memo by the Debevoise law firm about the opinion can be found here. Special thanks to the several loyal readers who send me copies of the Second Circuit's opinion.
Fourth Circuit Excoriates Prosecutors for Use of Uncivil Language: In a recent post (here), I quoted the pointed words of Central District of California Judge Dale Fischer in a hearing in one of the FDIC lawsuits arising out of the failure of IndyMac bank, in which she urged lawyers to cut the overheated rhetoric and to get to the point.
Judicial impatience with lawyers’ verbal excesses seems to be catching on. As noted in a February 16, 2012 post on the Volokh Conspiracy blog (here), the Fourth Circuit, in a footnote in a January 18, 2012 opinion (here), takes U.S. prosecutors to task for the language the lawyers used in their briefs in the case.
The footnote, which appears at the conclusion of the Court’s opinion (written by Fourth Circuit Judge Allyson Kay Duncan), opens with the observation that “we feel compelled to note that advocates, including government lawyers, do themselves a disservice when their briefs contain disrespectful or uncivil language directed against the district court, the reviewing court, opposing counsel, parties, or witnesses.”
The government’s brief, the Court notes, is “replete with such language;” : it “disdains the district court’s ‘abrupt handling’ of Appellant’s first case; “sarcastically refers to Appellant’s previous counsel’s ‘new-found appreciation for defendant’s mental abilities’”; criticizes the district court’s "oblique language" on an issue unrelated to the appeal; states that a district court opinion "revealed a crabby and complaining reaction to Project Exile;” insinuates that the district court’s concerns "require[ ] a belief in the absurd that is similar in kind to embracing paranormal conspiracy theories;" and accuses Appellant of being a "charlatan" and "exploit[ing] his identity as an African-American."
The Court said that “the government is reminded that such disrespectful and uncivil language will not be tolerated by this court.”
It certainly can be hoped that these two judicial reactions to the lawyers’ rhetoric represents a growing willingness to take a stand against lawyers’ use of excessive, vituperative or abusive language. There is no doubt that lawyers’ increasing willingness to use intemperate language of this type is disrespectful to the Court; inconsistent with basic notions of professionalism; and undermines civility in the profession. If courts were to become more engaged in calling out lawyers who employ excessive language of this type, perhaps lawyers might tone it down and keep things a little more civil.
In his blog post about the opinion cited above, Eugene Volokh includes an interesting additional gloss on the critical footnote, and also quotes at length from the letter of apology that the government lawyer responsible for the language wrote to the Court.
Chancellor Strine: In an interesting March 1, 2012 article in the American Lawyer (here), Susan Beck takes a detailed look at the new Chancellor of the Delaware Court of Chancery, Leo Strine. I commend the article to anyone who is interesting in business litigation in Delaware. And as Francis Pileggi pointed out in a March 3, 2012 post on his Delaware Corporate and Commercial Litigation Blog (here), Professor Stephen Bainbridge has also published an interesting perspective on Chancellor Strine, in a March 1, 2012 post on his Professor Bainbridge.com blog (here), in which Bainbridge compares Strine to one of the minor biblical prophets.
Strine has only been in the Chancellor position since last June, and he has already triggered a profusion of interesting commentary.