The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

I am pleased to present below a guest post from Angelo G. Savino of the Cozen O’Connor law firm discussing the Southern District of New York’s application of the Morrison decision in an SEC enforcement action pending against Goldman Sachs employee Fabrice Tourre. This guest post will also be published and distributed in the future as a Client Alert from the Cozen law firm.

My thanks to Angelo for his willingness to publish his guest post here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

Here is Angelo’s guest post::

On June 10, 2011, Judge Barbara Jones of the United States District Court for the Southern District of New York issued a decision in a case entitled SEC v. Goldman Sachs & Co., No. 10-3229 (“Goldman Sachs”), that applied the Supreme Court’s Morrison decision to claims by the SEC under both the Securities Exchange Act of 1934 and the Securities Act of 1933. Goldman had previously settled the claims against it for $550 million, but left Fabrice Tourre, a Goldman Vice President who had worked at its New York headquarters, to face the SEC’s claims. 

The decision is noteworthy because it is the first to apply Morrison, which held that section 10(b) of the Exchange Act does not apply extraterritorially, to claims by the SEC. It is also the first decision to provide a detailed analysis of the second prong of Morrison’s transactional test involving domestic transactions in securities that are not listed on an exchange. Lastly, the decision is the first to apply Morrison to section 17(a) of the Securities Act. 

The SEC alleged that in 2007, Goldman structured and marketed a synthetic collateralized debt obligation (“CDO”) called Abacus 2007-ACI (“Abacus”) that was based on the performance of subprime residential mortgage-backed securities (“RMBS”). CDOs are debt securities collateralized by other debt obligations such as, in this case, RMBSs. The complaint also alleged that Goldman was assisted by a hedge fund, Paulson & Co. Inc. (“Paulson”) in selecting the RMBSs that would collateralize the CDO. At the same time, Paulson allegedly entered into a credit default swap (“CDS”) that essentially bet that the RMBSs would perform poorly. According to the SEC, Goldman and Tourre marketed the CDOs without disclosing to investors that the underlying portfolio of mortgage-backed securities had been selected by Paulson while Paulson was betting against their performance. Tourre was allegedly the Goldman employee principally responsible for structuring and marketing the Abacus securities. 

The SEC also alleged that Goldman and Tourre marketed and sold $150 million worth of Abacus notes to IKB, a German commercial bank, and $42 million worth of notes to ACA Capital Holdings, Inc. (“ACA Capital”), a U.S.-based entity. ACA Capital also entered into a credit default swap involving a $909 million super senior tranche of Abacus. Essentially, ACA Capital assumed the credit risk associated with that portion of Abacus’s capital structure in exchange for premium payments. Thereafter, through a series of credit default swaps among ABN, Goldman, and ACA Capital, ABN assumed the credit risk regarding that $909 million tranche. ABN is a Dutch bank.

The closing for Abacus occurred in New York City and Goldman delivered the notes through the book entry facilities of Depository Trust Company in New York City. Tourre, however, provided the court with trade confirmation indicating that Goldman Sachs International, located in London, was listed as the seller of the notes to an IKB affiliate based on the Island of Jersey, a British dependency. Similarly, the CDS confirmations regarding the ABN transaction listed the seller as Goldman Sachs International and the purchaser as the London branch of ABN. 

The SEC claimed that Tourre had violated section 17(a) of the Securities Act and section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and aided and abetted violations of section 10(b). Tourre moved to dismiss and for judgment on the pleadings based on Morrison on the ground that the complaint failed to state a claim because it did not allege securities transactions that took place in the United States. 

Judge Jones first analyzed the SEC’s Exchange Act claims against Tourre. She noted that the Supreme Court, in Morrison, had adopted a clear transactional test: “whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.” Nevertheless, Judge Jones also noted that, because the securities at issue in Morrison were traded only on foreign exchanges, the Supreme Court was largely silent regarding how lower courts should determine whether a purchase or sale is made in the United States. That, however, was the issue she faced because the Abacus securities were not traded on an exchange. 

The court began its analysis of the issue by looking to the statutory definitions of “purchase” and “sale” in the Exchange Act, which were relatively “unhelpful.” The court then turned to case law and determined that the concept of “irrevocable liability” was at the core of both a “sale” and a “purchase.” The court noted that at some time a purchaser incurs irrevocable liability to take and pay for a security while a seller incurs irrevocable liability to deliver a security. 

In applying this concept to the IKB transaction, the court rejected the SEC’s arguments based on Tourre’s presence in New York while he engaged in structuring and marketing of Abacus on the grounds that it was merely conduct, which had been rejected as the determinative factor in Morrison. Judge Jones also rejected the SEC’s argument that courts must look to the “entire selling process” to determine whether a securities transaction is foreign or domestic. The court observed “in reality, the SEC’s ‘entire selling process’ argument is an invitation for this court to disregard Morrison and return to the ‘conduct’ and ‘effects’ tests.” 

The SEC had also conceded at oral argument that the closing in New York, by itself, was not sufficient to make IKB note purchases domestic transactions for purposes of Morrison. For good measure, however, the court noted Quail Cruises Ship Mgmt. v. Agencia De Viagens CVC Tur Limitada, which also rejected the place of closing as determinative under Morrison. Accordingly, the court concluded as follows: 

In view of the fact that none of the conduct or activities alleged by the SEC, including the closing, constitute facts that demonstrate where any party to the IKB note purchases incurred “‘irrevocable liability[,]’” . . . the SEC fails to provide sufficient facts that allow the court to draw the reasonable inference that the IKB note “purchase[s] or sale[s were] made in the United States.” 

Turning to the ABN transaction, the court stated that the SEC provided no facts from which the court could draw the reasonable inference that any party to the ABN CDS transaction incurred “irrevocable liability” in the United States. Thus, Judge Jones ruled that the SEC failed to allege that the ABN CDS transaction constituted a domestic transaction under Morrison for the same reasons as the IKB purchases. 

Because AKA Capital was based in the United States, there appears to have been no opportunity for the court to apply Morrison to those transactions. Instead, the court analyzed whether the SEC had sufficiently pled the elements of a violation of section 10(b), and found that it had. 

The court also analyzed the sufficiency of the SEC’s claim under section 17(a) of the Securities Act, and whether Morrison applied to that statutory section. The court observed that Morrison did not involve or consider section 17(a), none of the parties had cited any cases applying Morrison to section 17(a), and the court was not aware of any such case. Judge Jones observed that In re Royal Bank of Scotland Grp. PLC. Litig. applied Morrison to sections 11, 12 and 15 of the Securities Act, but did not address section 17(a). Nevertheless, the court agreed with Tourre that Morrison applies to section 17(a), stating that “Morrison itself expressly states that the Exchange Act and the Securities Act share ‘[t]he same focus on domestic transactions.’” Because Morrison focused on whether sales of securities were domestic or foreign, Judge Jones concluded that, to the extent section 17(a) applied to sales, it does not apply to sales that occur outside the United States. The court therefore dismissed the section 17(a) claim, but only to the extent that it was based on sales to IKB and ABN. 

The court continued its analysis, however, observing that section 17(a), unlike section 10(b), applies not only to sales of securities, but also to offers to sell securities. The court examined the definition of the term “offer” in the Securities Act, which states that an offer includes “every attempt to offer or dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” The court stated that this definition left no doubt that the focus of “offer,” under the Securities Act, was on the person or entity attempting, or offering, to dispose of, or soliciting an offer to buy, securities. Applying this definition to the allegations of the complaint, the court noted that the SEC alleged Tourre, acting from New York City, offered Abacus notes to IKB and solicited ABN’s participation in Abacus CDSs. The court observed that Tourre allegedly engaged in numerous communications from New York City that constituted domestic offers of securities or swaps. Thus, Judge Jones permitted the section 17(a) claim to survive to the extent that it was based on such “offers.” 

Conclusion

This case adds significantly to the jurisprudence applying the Supreme Court’s Morrison decision. As an initial matter, the case represents the first time that any court has applied Morrison to claims by the SEC. Because this action was brought prior to the enactment of Dodd-Frank, which purports to grant subject matter jurisdiction over extraterritorial claims by the SEC, it remains to be seen whether subsequent post-enactment SEC cases will follow this decision. It is arguable that Dodd-Frank should not change the Morrison analysis as applied to the SEC. Although Dodd-Frank purports to grant subject matter jurisdiction over extraterritorial securities claims by the SEC, the Supreme Court, in Morrison, held that district courts already had subject matter jurisdiction, but that section 10(b) itself had no extraterritorial reach. Nothing in Dodd-Frank modified section 10(b) in that regard. Thus, courts in post-enactment cases may conclude that they are able to follow Judge Jones’s decision in Goldman Sachs. 

In addition, the Goldman Sachs decision is significant for its analysis of how Morrison applies to transactions in securities that are not listed on an exchange. As Judge Jones noted, because Morrison involved securities traded on foreign exchanges, the decision is essentially silent on the second prong of its transactional test involving the purchase or sale of any other security in the United States. The Goldman Sachs decision furnishes a well reasoned analytical roadmap for other courts to follow in this respect. 

Lastly, the decision is noteworthy for its articulation of the applicability of Morrison to claims under section 17(a) of the Securities Act involving sales of securities, and to the Securities Act generally. 

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In a series of recent posts (most recently here), I have been taking a look at the practical impact that the U.S. Supreme Court’s June 24, 2010 decision in Morrison v. National Australia Bank will have on securities litigation in the United States involving non-U.S. companies. Among the cases seemingly most impacted by the decision is the Vivendi securities class action lawsuit pending in the Southern District of New York. Not only is the defendant company domiciled outside the United States, but about three quarters of its shareholders reside in France and most presumably purchased their shares on non-U.S. exchanges.

The question of whether these shareholders may assert a claim in a U.S. court under U.S. law is particularly acute due to the verdict that the jury returned on behalf of the plaintiffs in the case in January 2010.

As Andrew Longstreth reported on July 27, 2010 in the Am Law Litigation Daily (here), the parties to the Vivendi case recently presented their arguments to the court on the impact of Morrison. Among other things, the article characterized the plaintiffs’ argument that the foreign plaintiffs may proceed in the case as "highly creative" and the article also quoted George T. Conway III of the Wachtell Lipton law firm – who briefed and argued the Morrison case for the defendants – as describing the plaintiffs arguments as "Completely nuts, N-U-T-S."

After I linked to the Am Law Litigation Daily article, counsel for the plaintiffs in the Vivendi case reached out to me to express their concerns that their position has been misunderstood and is not receiving a fair hearing in the press and the blogosphere. In response, I offered to host a guest blog post on this site, in which the plaintiffs counsel could present their position as they wished. What follows is the guest post submitted to me by Michael Spencer of the Milberg law firm.

I encourage readers who have comments in response to Michael Spencer’s guest post to add their comments to this post using the site’s Comment feature.

I would like to thank Michael Spencer for his willingness to submit this post and have it published on this site. I welcome the opportunity to publish guest posts from responsible observers on this site. Those who may be interested in publishing a guest post on this site should feel free to contact me using the Contact function in the upper right hand column of this site.

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It was obvious from the first reading that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank represents a sweeping victory for the defendants. As I noted in my initial post after the decision came down, the Court’s holding that plaintiffs can’t pursue fraud claims for securities purchased on foreign exchanges will have a significant impact both on pending cases and on future filings.

On further reflection, it seems the case could have even more significant implications.

First, with respect to pending cases, it is worth noting that Vivendi itself believes, as I suggested in my prior post, that National Australia Bank ruling has significant implications concerning the jury verdict entered against the company in January 2010. Indeed, Vivendi issued a June 25, 2010 press release (here), in which it said that the company is "very satisfied" with the decision, commenting further that the Court’s ruling is "totally in line with the position defended all along by the Group in the American and French Courts."

According to prior press reports (here), as many as two-thirds of Vivendi’s investors live in France, and undoubtedly many of them, as well as many of Vivendi’s other investors that reside outside the United States, likely bought their shares on securities exchanges outside the United States. Under the transactional test the Court enunciated in the National Australia Bank decision, investors who bought their share on non-U.S. exchanges cannot pursue a claim under U.S. securities laws. It seems likely that the class of persons entitled to claim injury in the Vivendi case necessarily will be dramatically narrowed.

There are many other pending cases that are likely to be similarly affected. In a June 25, 2010 AmLaw Litigation Daily article (here), Andrew Longstreth examines the likely impact of the National Australia Bank case on the securities class action litigation filed under U.S. securities law against BP and certain of its directors and officers. BP’s common shares trade on the London Stock Exchange, and though many investors likely bought American Depositary Receipts for BP on U.S. exchanges, many of its shareholders more likely bought their shares in the U.K. (The AmLaw article notes that 28% of BP’s equity is in ADRs, so those shares are unlikely to be affected by the Supreme Court’s recent decision.)

Other cases that are likely to be affected by the Supreme Court’s decision include the action brought against Porsche, which was sued in January 2010 by short sellers of Volkswagen stock who claimed Porsche secretly cornered the market in Volkswagen shares but denied that it intended to acquire Volkswagen. According to a June 25, 2010 Bloomberg article (here) discussing the impact of the National Australia Bank decision on the Porsche case, the plaintiffs claims in the case are likely reduced only to "causes of action based on low-volume American depositary shares."

A number of foreign-domiciled companies that have been the target of securities class action litigation under U.S. securities laws filed amicus briefs in the National Australia Bank case; the cases filed against many of these companies, including EADS and Alstom, seem likely to be substantially affect by the Court’s holding.

Other recently filed cases also seem likely to be affected, including the cases recently filed against Toyota,

Securities suits against foreign companies have in recent years been a significant part of overall securities lawsuit filings in recent years. For example, 24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. In 2008, there were 34 foreign domiciled companies sued in securities class action lawsuit, or about 15% of all filings that year.

Not all of these securities suits are necessarily going to be affected by the National Australia Bank case. For example, the lawsuit filed earlier this year against Nokia was at the very outset brought only on behalf of investors who bought their American Depositary Shares in the company on U.S. exchanges. Similarly the lawsuit filed late last year against Siemens was brought solely on behalf of purchasers of the company’s American Depositary Receipt shares.

The fact that cases against foreign companies with securities trading on U.S. exchanges may still be susceptible to securities class action litigation in U.S. court because their securities trade on U.S. exchanges could well discourage some overseas companies from having their shares trade here.

While there will still be circumstance even after National Australia Bank in which securities suits in U.S. courts against foreign-domiciled companies will still be filed and will still go forward, it seems probable that many other cases that might have been filed in the past will now simply go unfiled, at least in the U.S -- particularly in those cases where the foreign companies do not have significant numbers of ADRs or other securities trading on U.S. exchanges.

Given what a significant percentage of total U.S.-based securities class action filings these actions against foreign companies have become in recent years, the reduction in these filings could mean a material reduction in the overall level of securities class action filings (although please see my comments below about some other possibilities for U.S.-based litigation.)

The fact that investors who bought shares on foreign exchanges can no longer access U.S. courts clearly creates a problem these investors. As the filing levels described above demonstrate, these investors increasingly had come to rely on the U.S processes and remedies as a way to seek redress when they felt they had been misled, at least where the alleged fraud involved U.S-based conduct.

Indeed, numerous foreign institutional investors had filed amicus briefs in the National Australia Bank case (refer for example here), arguing that "both foreign and domestic investors alike rely on American Law to ensure that corporations doing business in America are not tainted by fraud."

Now that these investors can no longer "rely on American Law" in many instances, these investors will have to consider their alternatives. One possibility is that these investors will increasingly rely on remedies in their own country. Without access to U.S. courts, these and similarly situated investors may find action in their domestic courts more attractive.

For that matter, without access to U.S remedies and processes, investors in foreign countries may press for the implantation of legal reforms in their home countries to permit them better means of attempting to recoup losses based on alleged fraud.

Of course, resourceful plaintiffs’ lawyers in this country are now highly motivated to try to find ways around the National Australia Bank decision. Some possible ways it might be circumvented include filing individual lawsuits in state court under state law, and filing federal court class actions alleging state law violations. Claimants in these kinds of cases arguably may face the same hurdles of trying to show that the relevant law provides remedies regarding securities transactions on foreign exchanges, but the existence of U.S.-based fraudulent conduct potentially could provide a sufficient basis for relief under many legal theories, even if not under the federal securities laws.

Another possibility is that the foreign institutional investors and others may seek legislative change in the U.S. in order to establish a new statutory basis for relief in U.S. courts for investors who bought shares overseas, at least where there is U.S.-based conduct involved in the alleged fraud. As I pointed out in my prior post, legislative initiatives in the current Congress proposed to do that very thing.

As Luke Green points out in his post on the Risk Metrics Securities Litigation blog (here), the National Australia Bank case does not carve out an exception for the SEC and the DoJ, and there may be considerable interest providing statutory means for these agencies to pursue remedies for U.S.-based fraudulent conduct even if in connection with transactions on foreign exchanges. (Green also has a number of other interesting thoughts and comments about the decision.)

UPDATE: An alert reader points out that in the Conference Committee of the financial reform bill (called "The Dodd-Frank Wall Street Reform and Consumer Protection Act", here ) there are provisions addressing these questions of extraterritoriality. First, Section 929P(b) authorizes an action brought by the Commission based on a statutorily defined conduct and effects test. Second, Section 929Y directs the Commission to study whether private rights of action should be allowed on the same basis as authorized for the Commission in 929P(b). The Commission is to report to Congress within 18 months of the statute's enactment.

The bottom line is that National Australia Bank is an important decision that will have a number of significant impacts, some immediately and some in the months and years to come. Some of the impacts are obvious and apparent now, and some will only become apparent over time.

The National Australia Bank case does underscore how significant it is when the U.S. Supreme Court decides to take up a securities case. Each occasion represents a context within very significant changes in the interpretation or application of the U.S. securities laws potentially could occur, as proved to be the case here. Full consideration of this possibility makes it all the more interesting and potentially significant that the Supreme Court recently agreed to hear the Matrixx Initiative securities suit. This development raises the possibility for even further landscape altering case law from the U.S. Supreme Court in its next term.

It’s Not Over Yet, Folks: While it is not too early to start looking ahead to the Supreme Court’s next term, it is also worth noting that this current term is not yet complete, as the Court has yet to issue decisions in four high profile cases. As noted on the WSJ.com Law Blog (here), these four decisions are likely to be issued on Monday, June 28, 2010.

Among the four cases yet to be decided is Free Enterprise Fund v. PCAOB, which will address the question whether it was appropriate for Congress to give authority to the SEC to name the members of the Public Company Accounting Oversight Board. The case raises basic questions about the separation of powers between the Executive and Legislative branches and potentially could address the question of the constitutionality of the Sarbanes Oxley Act.

Depending on how the Court rules, this case could potentially be very significant, particularly if the Court reaches the constitutionality question. As the WSJ.com Law Blog comments, "If the justices agree that the accounting board isn’t constitutional, it could force Congress to revisit Sarbanes-Oxley, or at least the portion of it that creates the accounting board. It could also call into question other independent agencies and how they appoint members of similar boards."

More World Cup Notes:

1. A tip of the hat to the Ghanians, who played with speed, skill and opportunism and did what they had to do to win an exhausting, exciting game.

2. A final salute to the Americans, too, who played all four of their games with heart and class and who are going home simply because there is a limit to how many times a team can come from behind. Landon Donovan's winning goal in extra time last Wednesday against Algeria is one of the great moments of this World Cup.

3. England's fans have to be beside themselves over Frank Lampard's disallowed goal late in the first half of their game against Germany. On the other hand, as unjust as the disallowance was, England pretty much got beat, by a clearly better team. .

4. The Mexicans have a legitimate gripe about Argentina's first goal on Sunday. Carlos Tevez was clearly offsides. However, poor officiating had nothing to do with the total defensive breakdown that allowed Gonzalo Higuain's goal for Argentina's second score, and the Argentiines' third goal was a magnificent strike from Tevez. The Germany/Argentina game next week should be terrific.

5. If, as seems likely at this point, FIFA spends the next four years trying to figure out how to improve  the offciating at the next World Cup, I hope they will also take a hard look at ways to better enforce the rules against embellishment. Too many players seem more inclined to flop than to play. It really is revolting.

6. The French don't have to worry about anybody disrespecting them, because there's really no need -- the French have done such a masterful job of it themselves. The Irish can be excused for any pleasure they might be taking from the French team's embarrassment.

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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.

Background

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.

Discussion

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.

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In a November 26, 2008 opinion (here), the Ninth Circuit affirmed the lower court’s dismissal of a lawsuit asserting securities law violations against InVision and certain of its directors and officers based on FCPA-related disclosures. The case is noteworthy not only for its involvement of FCPA-related allegations, but also for the appellate court’s consideration of "collective scienter" issues, as well as of the significance of Sarbanes-Oxley certification issues.

Background

On March 15, 2004, InVision announced it would be acquired by GE in a cash-for-stock transaction. That same day, the company filed its annual filing on Form 10-K to which the merger agreement was attached. On July 30, 2004, InVision announced that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act (FCPA). The company voluntarily reported the activities to the SEC and the DOJ. The company later entered negotiated arrangements with the DOJ and the SEC (refer here). GE later consummated the pending merger.

Shortly after InVision announced the FCPA concerns, shareholders initiated a securities class action lawsuit against the company and certain of its directors and officers. (Refer here for further background regarding the case). The plaintiffs based their claims on three alleged misstatements in the merger agreements, which InVision had attached to its 10-K.

The plaintiffs alleged that the merger agreement misleadingly stated that the company was "in compliance … with all applicable law"; in compliance with the "books and records" provision of the FCPA; and that that neither the company nor any of its officers, directors or employees had knowledge that the company had violated the FCPA’s antibribery provisions.

The district court dismissed the complaint and the plaintiffs appealed.

The Ninth Circuit’s Decision

The appellate court essentially assumed that the plaintiff had satisfied the requirement to plead falsity with respect to the three alleged misrepresentations stating that "even if [the plaintiff, Glazer] properly pled falsity, the district court’s dismissal would still be appropriate if Glazer failed to plead scienter adequately with respect to the three statements."

In order to satisfy the scienter requirement, the plaintiff urged the Ninth Circuit to adopt the "collective scienter" theory, following the Second Circuit’s recent decision in the Dynex Capital case (refer here) and the Seventh Circuit’s recent decision in the Tellabs case (refer here). Under this theory, as articulated by the Seventh Circuit, "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud."

After reviewing the case law concerning corporate securities liability, including its own prior decision in the Nordstrom v. Chubb case (a decision that will be familiar to many of this blog’s readers), the Ninth Circuit ultimately concluded that this case did not require the court to decide whether or not to adopt the theory of collective scienter.

The court concluded that because of "the limited nature and unique context of the alleged misstatements" involved in the case, the "collective scienter" issue was not before the court. In reaching this conclusion, the court noted that

Glazer rests its securities fraud claim on three statements, all of which appear in a sixty-page legal document. If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance "with all laws," then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.

 

Accordingly, the Ninth Circuit held that in order to succeed on his claim, the plaintiff had to establish that individual defendants acted with scienter in making the statements in the merger agreement. The court said that "we see no way that [the defendant] could show that the corporation, but not any individual [director or officer] had the requisite intent to defraud." Only the company’s CEO and CFO had signed the merger agreement, and the plaintiff alleged scienter only with respect to the CEO, Magistri.

The court found with respect to Magistri, however, that Glazer had not pled any facts to demonstrate that "Magistri was personally aware of the illegal payments or that he was actively involved in the details of the details of InVision’s Asian sales."

The Ninth Circuit also refused to infer scienter from the CEO’s and the CFO’s signature of the Sarbanes-Oxley certifications, holding that the mere signature, without more, is insufficient to raise a strong inference of scienter.The Ninth Circuit followed prior decisions of the Eleventh and Fifth Circuits, concluding that there was no evidence that the SOX certification requirements were intended to alter the PSLRA’s pleading requirements. The Court said that "the Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.

Discussion

The Ninth Circuit’s decision is noteworthy for its discussion of the "collective scienter" issue, although in the end it is of limited significance on this point given the court’s conclusion that it did not need to reach that issue. The decision is also noteworthy for its discussion of the Sarbanes-Oxley certification issue, but in that respect it also merely followed existing precedent.

But perhaps the greatest significance about the Ninth Circuit’s opinion may be what it suggests about securities cases based on FCPA-related disclosures. The Ninth Circuit’s refusal to allow the claim to proceed in the absence of allegations that senior officials were aware of the improper conduct could present a significant hurdle for FCPA-related securities claims, at least in the circuits that have not adopted the "collective scienter" theory.

As the Ninth Circuit noted in the InVision case, "the surreptitious nature of the transactions creates an equally strong inference that the payments would have deliberately kept secret – even within the company." Obviously, payments of this kind invariably are of a surreptitious nature and of a kind that would be kept secret, even within the company. The implication is that in order for a securities claim alleging FCPA-related disclosures to survive the initial pleadings stage, the claimants may have to plead that the company officials who prepared the company’s public disclosures were aware of the improper activities.

In prior posts (most recently here), I have noted the increasing prevalence of follow-on civil litigation accompanying FCPA investigations, including the increasing frequency of follow-on securities litigation alleging misrepresentations in the FCPA-related disclosures. The Ninth Circuit’s decision in the InVision case suggests that, at least in jurisdictions that have not recognized the collective scienter theory, the ability of these follow-on securities lawsuits to get past the pleading stage may depend on the existence of allegations that senior company officials were aware of the improper payments. Given the invariably "surreptitious nature" of these payments, claimants may find this a challenging requirement to satisfy.

The SEC Actions blog has a thorough analysis of the Ninth Circuit’s discussion of the pleading issues in the InVision case, here. The FCPA Blog also has a good discussion of the case, here.

Special thanks to Neil McCarthy of Lawyerlinks.com for providing me with a copy of the Ninth Circuit’s opinion.

Another New Wave Securities Lawsuit: In a recent post (here), I noted that there have been several recent securities class action lawsuits in which the companies involved have been hit with significant losses due to wrong way bets on commodities or currencies.

The latest example of this type of securities litigation involves a case filed on November 26, 2008 in the Southern District of Florida against Brazilian forest products manufacturer Aracruz Cellulose S.A. and certain of its directors and officers on behalf of investors who purchased the company’s American Depositary Receipts on the NYSE., as well as purchasers of the company’s common stock, which trades on the Sao Paulo Bovespa.

According to the plaintiffs’ lawyer November 26 press release (here), the complaint alleges that

During the Class Period, Aracruz entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the use of these contracts as protection against foreign interest rate volatility and assured investors that this type of trading did not represent "a risk from an economic and financial standpoint." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations. As a result of Aracruz's clandestine and speculative currency wagers, credit rating agencies downgraded Aracruz, the Company's CFO resigned, and Aracruz's stock suffered a severe decline, plummeting to the lowest levels in 14 years.

As I noted in my prior post, many companies were also exposed to sudden and unexpected losses by dramatic changes in the commodities and currencies markets earlier this year. For example, the November 29, 2008 Wall Street Journal reported (here) on several airlines that have recently reported the negative impact from fuel cost hedges that generated huge losses. These kinds of developments and other unexpected fallout from the crisis roiling global financial markets are likely to affect a wide variety of companies, some of which may be subject to securities litigation.

It is interesting to note that the plaintiffs’ lawyers in the Aracruz case appear to have made a conscious decision to include within the class the Brazilian company’s common shareholders. Within this group are likely to be a number of shareholders domiciled outside the U.S. that bought their shares against the foreign company on a foreign exchange. The presence of these so-called "foreign-cubed" litigants could pose subject matter jurisdiction issues, at least as to those claimants.

My recent post discussing the Second Circuit’s recent "foreign-cubed" litigant ruling in the National Australia Bank case can be found here. The November 24, 2008 Southern District of New York decision granting the motion to dismiss the securities class action lawsuit that had been filed against Vodafone for lack of subject matter jurisdiction, in reliance upon the National Australia Bank decision, can be found here. (Note: Special thanks to the reader who pointed out that I had incorrectly referred to the Vodafone case as the Vivendi case. My apologies for any confusion.)

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On October 23, 2008, in a much-anticipated decision addressing what it called "the vexing question of the extraterritorial application of the securities laws," the Second Circuit in the National Australia Bank (NAB) case ruled (here) that U.S. courts lack subject matter jurisdiction over the claims of foreign claimants in that case who bought their NAB shares on a foreign exchange. Although the Second Circuit did not, as friends-of-the-court had urged, pronounce a bright line rule against jurisdiction in such "f-cubed" claims, it nevertheless provided guidelines that will be relevant to similar cases going forward.

Background

NAB is Australia’s largest bank. Its shares trade on securities exchanges in Australia, London, Tokyo and New Zealand. Its American Depositary Receipts trade on the New York Stock Exchange. NAB has a mortgage servicing subsidiary, HomeSide, based in Florida. In 2001, NAB disclosed that it was taking a significant write-down due to a recalculation of the amortized valuating of HomeSide’s mortgage servicing rights. Following this announcement, the price of NAB’s shares and ADRs declined, and investors filed a securities class action lawsuit in the Southern District of New York.

The claim was initially brought by four plaintiffs. One of the four purported to represent domestic purchasers of NAB’s securities. The three other plaintiffs bought their shares abroad and sought to represent a class of non-U.S. purchasers. Background regarding the case can be found here.

On October 25, 2006, the District Court granted defendants’ motion to dismiss the complaint. The District Court held that it lacked subject matter jurisdiction over the foreign claimants claim. The court dismissed the domestic plaintiff’s action for failure to state a claim because the domestic plaintiff failed to allege that he suffered damages. The three foreign plaintiffs appealed. The domestic plaintiff’s claim was not before the Second Circuit, and so the appellate court was exclusively concerned with the jurisdictional issue.

The Second Circuit’s Opinion

In its October 23 opinion, written by Judge Barrington Parker, the Second Circuit noted that the "difficulty of the case was heightened by its novelty" – that is, the involvement of so-called "foreign-cubed" claimants. The appellees and several amici had urged the Second Circuit to adopt a "bright-line rule" by holding that in "foreign-cubed" securities litigation that mere domestic conduct should not be enough for a U.S. court to exercise subject matter jurisdiction where the conduct had no effect in the U.S. Links to the briefs for the parties and the amici can be found here. My prior post detailing the issues surrounding "f-cubed claims" generally can be found here.

The Second Circuit duly acknowledged what it characterized as the "parade of horribles" the friends-of-the-court invoked in favor of a bright line test, including the possibility that exercising jurisdiction in those cases could bring U.S. securities laws in conflict with those of other jurisdictions.

However, the Second Circuit observed that declining jurisdiction over all "foreign cubed" cases "would conflict with the goal of preventing the export of fraud from America." In particular, the Court was concerned that the U.S. should not be seen as a "safe haven for cheaters." The court said that "we are leery of a rigid bright line rule because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result on their being subject to American jurisdiction."

Having rejected the bright line test, the Court went on to observe that "we are an American court, not the world’s court, and we cannot and should not expend our resources resolving cases that do not affect Americans or involve fraud emanating from America." The Second Circuit said that "in our view the ‘conduct text’ balances those competing concerns." Under the conduct test, subject matter jurisdiction exists "if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad."

The Court then turned to applying the conduct test to the NAB case. The claimants urged that because miscalculation of HomeSide’s mortgage servicing rights had taken place in this country, U.S. courts could exercise jurisdiction. The Second Circuit nevertheless determined that U.S. courts lack jurisdiction, citing three factors: "the fraudulent statements at issue emanated from NAB’s headquarters in Australia; the complete lack of any effect on America or Americans; and the lengthy chain of causation between HomeSide’s actions and the statements that reached investors."

Discussion

Though the defendants in the NAB case prevailed, the case hardly means the end of f-cubed litigation. Arguably, in light of the Second Circuit’s refusal to adopt a bright line test, the jurisdictional standards remain largely unchanged, and litigants will continue to argue whether there is sufficient U.S. based conduct and U.S based effects to support the U.S. court’s exercise of jurisdiction.

Moreover, the Second Circuit made it clear that there will be circumstances in which it will be entirely appropriate for U.S. courts to exercise jurisdiction over the f-cubed claims. For that reason, and even though the Second Circuit held that the U.S. courts lacked jurisdiction of over the NAB case itself, foreign claimants likely will continue to try to assert claims against foreign-domiciled companies in U.S. courts.

That said, the claimants case against NAB did get tossed. The Second Circuit did caution against U.S. courts presuming to act as "the world’s court" and also cautioned against the exercise of jurisdiction over claims that do not affect Americans or involve fraud emanating from America. In other words, not all foreign claimants’ claims against foreign domiciled companies will go forward in U.S. courts.

Moreover, these issues are relevant not only at the motion to dismiss stage but also at the other procedural stages, including the lead plaintiff stage (refer here). As Adam Savett noted on the Securities Litigation Watch blog (here), courts have been increasingly willing to craft class certification to exclude foreign domiciled claimants at least in certain circumstances.

All of that said, the NAB decision will be grist for the mill in the onslaught of litigation involving foreign domiciled companies sued in connection with the current subprime and credit crisis litigation wave. The NAB decision necessarily implies a case-by-case determination and so litigants will continue to wrestle to determine whether these cases will go forward in U.S. courts. In the meantime, the cases will continue to be filed.

An October 23, 2008 Bloomberg article discussing the case can be found here.

Special thanks to George T. Conway, III of the Wachtell, Lipton law firm, who successfully represented NAB in the Second Circuit, for providing me with a copy of the opinion.

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The calamity that began as a U.S.-based subprime mortgage meltdown has now grown into a global financial crisis that has resulted in bankruptcies and bailouts involving some of the world’s largest financial institutions. Along the way, these financial institutions’ investors have seen their investment interests damaged or destroyed, leaving many angry and aggrieved. If a new lawsuit is any indication, investors aggrieved by their lost investments in global financial institutions may be turning to the U.S. courts for redress.

As reflected in their press release (here), on October 22, 2008, plaintiffs’ attorneys filed a purported securities class action in the Southern District of New York on behalf of investors who purchased securities of the recently nationalized Belgium-based financial services company, Fortis N.V. , related entities, and certain of its directors and officers.

According to the press release, though the company portrayed itself as stable and largely immune to the turmoil that was sweeping financial markets, "the Company was practically insolvent at all relevant times and needed to sell assets at fire-sale prices and raise capital at extraordinarily high rates to remain viable."

The press release states that the company’s balance sheet was impaired by assets acquired in connection with the company’s October 2007 acquisition of ABN AMRO.

On September 29, 2008, the governments of Netherlands, Belgium and Luxembourg agreed to bailout the company, but only if it were to sell its troubled stake in ABN AMRO. A September 30, 2008 Wall Street Journal article about the action of the three governments, and the role of the ABN AMRO transaction, can be found here. Even though the deal was in the form of an emergency infusion of 11.2 billion Euros ($16.9 billion), it was "not enough to stem Fortis’ continued decline."

On October 4, 2008, the Dutch government took over the company’s operations for 16.8 billion Euros ($23 billion). As the plaintiffs’ lawyers’ press release puts it, "news that the famed financial giant was in ruins and required nationalization further punished Fortis’ already bruised stakeholders." An October 6, 2008 Wall Street Journal article describing the government takeover, including the sale of Fortis banking and insurance assets to BNP Paribas, can be found here.

The plainitffs' lawyers' press release adds:

On October 14, 2008, Fortis traded on the Brussels exchange at the lowest levels that it had ever seen since it was formed 18 years ago, after selling most of its operations to three governments and BNP Paribas SA. Fortis, which resumed trading after a six-day suspension, declined 78 percent to 1.22 euro, valuing the Company at 2.86 billion euros ($3.91 billion).

The complaint in this case, which can be found here, apparently purports to be filed on behalf of  ALL investors who bought Fortis shares between January 28, 2008 and October 6, 2008, and not just U.S. domiciled investors or those who bought their shares on exchanges in the U.S. (where Fortis shares trade over the counter). The complaint specifically alleges that Fortis shares trade on the Brussels, Euronext and Luxembourg stock exchanges, as well as in the U.S.

To the extent the class action purports to be filed on behalf of foreign-domiciled investors who bought their shares in Belgium-domiciled Fortis on foreign exchanges, the case appears to present a classic instance of the so-called "f-cubed" problem (the reference is to the three foreign connections – foreign corporate domicile, foreign investor domicile, and foreign exchange location).

This case does not present the extreme situation represented in the lawsuit filed against EADS (and about which I wrote here) in which the foreign company's shares did not trade in the U.S. at all, but it nevertheless does present all the jurisdictional problems associated with subjecting foreign domiciled companies to potential liability under U.S. securities laws. As I noted here in connection with the recent ruling in the AstraZeneca case, courts increasingly are showing reluctance to project U.S securities liability in connection with f-cubed claims.

There is of course a well-established pattern of foreign domiciled companies becoming involved in U.S. securities litigation. Indeed, just in connection with the current subprime and credit crisis-related litigation wave, there have been U.S. securities lawsuits that have been filed against, Société Générale, Swiss Re, Deutsche Bank, and UBS, among many others.

What sets this most recent lawsuit against Fortis apart from these prior cases, at least in my mind, is that it relates so directly to the dramatic actions of foreign governments to try to salvage the company. These circumstances involve a magnitude, a depth of clearly foreign involvement and interests, and a combination of purely global financial circumstances that could be far beyond the purview of a U.S based court. To be sure, there may well have been misrepresentations made in connection with these events (the complaint certainly makes numerous allegations to that effect), and there may well of course have been misrepresentations of a kind for which the U.S. laws are designed to provide provide relief, which of course will have to be determined at a later date.

The case also involves such a vivid example of the momentous events that have moved across the global financial stage in recent weeks. The litigants will of course present their arguments about whether and to what extent a U.S. court is the appropriate forum here. Those of us not directly involved in the case may ask whether U.S. courts appropriately should perform roving inquests on the bailouts and bankruptcies that emerge around the globe as a result of the current financial crisis.

In any event, the Fortis lawsuit may represent another example of the new wave of credit crisis-related litigation, where the connection to the subprime meltdown is indirect, and the events that triggered the lawsuit are related to the catastrophic events in the financial market place that began to unfold in September 2008. My most recent prior post on this new litigation wave can be found here. On the other hand, it may also be argued that the problems Fortis faced are simply the result of the subprime mortgage exposure and subprime-related investments of the company it acquired, much the same as, for example, Wachovia was exposed to the subprime-related problems from Golden West, which Wachovia acquired.

Here Be Dragons: The ill-fated ABN AMRO transaction is a veritable treasure trove of excesses, extremes and subsequent moral lessons. Undoubtedly a book will be written some day about how the investor consortium led by Royal Bank of Scotland, and including Fortis, outbid (to the consortium’s eternal regret) the prior ABN AMRO bid of Barclays. Until the book comes out, readers may want to refer to the highly abridged version of events on Wikipedia, here.

Were there not so many other current events, the financial pages undoubtedly would be full of what-went-wrong retrospectives on the ABN AMRO deal. It is one more of those amazing things about the current circumstances that, despite the size of the ABN AMRO calamity, it is effectively just background noise in the larger cataclysm.

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In prior posts (refer here), I have discussed the increasing reluctance of U.S. courts to exercise subject matter jurisdiction over securities claims against foreign-domiciled companies brought by foreign claimants who bought their shares on foreign exchanges (so-called “f-cubed” claimants).

In the most recent example of this, Judge Thomas Griesa of the United States District Court for the Southern District of New York, in a June 3, 2008 opinion (here), granted the defendants’ motion to dismiss the claims of “f-cubed” claimants against AstraZeneca and certain of its directors and offices.

The complaint essentially alleges that Exanta, a pharmaceutical being develop by the AstraZeneca (a U.K.-based company) “was not as safe or effective as defendants’ public statements made it out to be.” The plaintiffs’ claimed that these statements inflated the company’s share price. Refer here for background regarding the lawsuit.

The outcome of the subject matter jurisdiction question was probably tipped in the court’s opening observation that “over 90% of the members of the putative class are foreigners who purchased their shares on foreign exchanges.”

The court reviewed the propriety of its exercise of jurisdiction over claims brought on behalf of these foreign shareholders, by considering whether or not there were sufficient allegations of U.S.-based conduct causing sufficient U.S.-based effects. The court found that while there were sufficient allegations of U.S.-based conduct, plaintiffs “do not allege facts in support of the second prong of the test – that the United States conduct ‘directly caused’ plaintiffs’ losses.”

The court said that in order to establish this requisite causal link, the plaintiffs must have “sufficiently alleged that the foreign purchasers relied on United States based conduct when deciding to acquire the stock”. In order to establish this kind of reliance, the plaintiffs urged the court in effect to adopt a global “fraud-on-the-market” theory, arguing that “it is illogical to suggest that the fraud-on-the-market theory applies within the United States but not outside of it.”

The court noted that other courts had rejected the global fraud-on-the-market theory, out of concerns that it would “extend the jurisdictional reach of the United States securities laws too far.” The court further noted that the Second Circuit had not yet provided guidance on whether the fraud-on-the-market theory should apply to foreign countries, and “in the absence of clear authority in favor of a global fraud-on-the-market theory, the court declines to adopt such a theory.” The court dismissed the claims of the foreign claimants based on lack of subject matter jurisdiction.

The court further concluded that the plaintiffs had not sufficiently alleged that two foreign-domiciled individual defendants had the requisite “minimum contacts” with the U.S. for the court to exercise personal jurisdiction over them.

Finally, the court concluded that the plaintiffs had not sufficiently pled scienter, and dismissed the remaining claims on that basis. The court held that neither the allegations of insider trading nor the allegations relating to a secondary offering were sufficient to establish scienter.

The court further rejected the plaintiffs allegations that the defendants had consciously disregarded the truth, based on the court’s own review of the various disclosure documents on which the plaintiffs sought to rely. The court concluded that the plaintiffs “have not alleged anything to negate the idea that that defendants were attempting to develop a drug they thought beneficial and were do describing it to the public.” The court found that the plaintiffs had “not alleged an inference of scienter as compelling as the opposing inference.”

The fact that the case will not be going forward even as to the domestic shareholders reduces the impact of the court’s ruling to exclude the f-cubed claimants from the class. The dispersion of the class, with such an overwhelming percentage of f-cubed claimants in the purported class members may well have inclined the outcome on the jurisdictional issue in any event.

Plaintiffs’ attorneys in the most recently filed cases seem to be anticipating that courts are inclined to exclude these claimants from the putative class and increasingly are taking that into account in their initial pleadings. For example, as discussed here, when plaintiffs’ lawyers recently launched a U.S. securities lawsuit against Société Générale, they included in the purported class only U.S residents and investors who bought ADRs on U.S. exchanges. Their purported class by its own construction excludes foreign residents who bought shares on foreign exchanges.

The increasing exclusion of f-cubed litigants from U.S. securities class actions (whether voluntary or as a result of court action) is one of the reasons that interest in U.S.-style securities relief is increasing in other countries, as I discussed in a recent post (here).

In any event, the court’s dismissal of the AstraZeneca case also continues another trend, which is that while life sciences companies are frequently sued (compared to companies in most other categories), the cases filed against them are often dismissed, as I also discussed in a prior post (here)

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The wave of subprime-related securities class action litigation has continued to spread, as plaintiffs’ lawyers have filed new securities lawsuits against two different companies.

First, according to their March 12, 2008 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the United States District Court for the Northern District of California (complaint here), against residential mortgage insurer The PMI Group. The lawsuit follows the company’s March 3, 2008 announcement (here), in connection with its fourth quarter earnings release, that it would delay filing its Form 10-K for year-end 2007 due to delays in obtaining 2007 financial results from recently downgraded bond insurer FGIC , in which PMI Group has a 40% ownership interest.

According to the plaintiffs’ attorneys’ press release, the complaint alleges that the defendants failed to disclose to investors that:

(a) the Company’s investment in FGIC was materially impaired as FGIC’s bond insurance arm, Financial Guaranty, had significant exposure to defaults on bonds it insured due to the plunge in value of mortgage debt; (b) the Company was materially overstating its financial results by failing to properly value its investment in FGIC and by failing to write down that investment in a timely fashion in violation of Generally Accepted Accounting Principles (“GAAP”); (c) the Company was not adequately accounting for its loss reserves in violation of GAAP, causing its financial results to be materially misstated; (d) the Company failed to engage in proper underwriting practices for its book of business related to insurance written in 2005 through most of 2007; (e) the Company had far greater exposure to anticipated losses and defaults related to its book of business related to insurance written in 2005 through most of 2007 than it had previously disclosed; (f) given the deterioration and the increased volatility in the subprime market, the Company would be forced to tighten its standards and stop writing insurance policies to certain categories of borrowers which would have a direct material negative impact on its book of business going forward; and (g) given the increased volatility in the subprime market, the Company had no reasonable basis to make projections about its incurred losses or about its new insurance written.

The second of the new securities class action lawsuits involves Société Générale. As I noted in a prior post (here), SocGen has previously been sued in a French court on behalf of 130 individual investors and certain companies. But according to their March 12, 2008 press release (here), plaintiffs’ lawyers in the U.S. have now filed an action in the United States District Court for the Southern District of New York under. U.S. securities laws against SocGen and its Chairman and CEO. The complaint can be found here.

According the plaintiffs’ press release, the plaintiffs allege that the defendants

·        made false and misleading statements and concealed material adverse information regarding SocGen's exposure to subprime loans, collateralized debt obligations ("CDOs") and SocGen's internal controls

·        touted SocGen's conservative management, risk control, and expertise in risk analysis and structured finance, including CDO vehicles

·        misled investors by announcing that it had "very little exposure" to the subprime segment

·        ignored or failed to act upon numerous alerts which should have led to the uncovering of Jerome Kerviel's massive irregular trading activity from 2005 through early 2008

The press release states that the case “also involves alleged insider trading by SocGen’s top U.S. executive and board member, Robert A. Day (I discussed Day’s trading in the company’s shares at length in my prior post, here).

One of the interesting features of the SocGen securities lawsuit is the class of investors on whose behalf the lawsuit purports to be brought. The complaint describes the class as consisting of all purchasers of the company’s American Depositary Receipts (which trade on the OTC market), and “all U.S. citizens who purchased SocGen securities on any exchange,” between August 1, 2005 and January 23, 2008.

By narrowing the class to include only investors who bought ADRs on the OTC and U.S. investors in general regardless of where they bought their SocGen securities, the plaintiffs clearly are seeking to avoid the jurisdictional and class certification issues that can arise in U.S. class actions against overseas companies involving overseas investors who bought their shares overseas.

As I have discussed in prior posts (most recently here), courts have wrestled with the so-called “f-cubed” litigants (foreign investors who bought their shares in foreign companies on foreign exchanges) and those issues have created complicated jurisdictional and class certification issues (as discussed here and here). The SocGen plaintiffs’ complaint seems calculated to try to avoid these issues, and possibly even to try to avoid conflicts with the prior French lawsuit.

The exclusion of the “f-cubed” litigants from the purported class does raise the question of where these investors are left, particularly if they would like to pursue remedies under U.S. securities laws. Clearly, they retain the option of bringing individual or group actions – what might be called the “left out” actions, by contrast to the more common “opt out” actions. As noted on the Securities Litigation Watch blog, here, that is what has happened with the overseas investors who were precluded from the class in the Vivendi class action; they have filed extensive individual actions.

While the subprime litigation wave has involved lawsuits against a wide variety of kinds of companies, the lawsuit against The PMI Group is the first case of which I am aware involving a residential mortgage insurer – although the lawsuit arises in part due to The PMI Group’s investment in troubled bond insurer FGIC, and there have been numerous prior subprime-related lawsuits against bond insurers.

In any event, as reflected in my running tally of subprime related securities lawsuits (which can be accessed here), the addition of these two lawsuits brings the total of subprime-related securities lawsuits to 49, ten of which have been filed in 2008.

Federal Securities Class Action to Proceed State Court: As discussed at length in a prior post (here) concerning two securities class actions that have been launched against mortgage-backed asset securitizers, the plaintiffs’ lawyers filing these actions chose to file the lawsuits in state court, in reliance on the concurrent state court jurisdiction under the ’33 Act. As I also noted in the prior post, the defendants in Luther v Countrywide Home Loans Servicing removed the case to federal court.

In a February 28, 2009 order (here), Judge Mariana R. Pfaelzer held that the lawsuit had not been properly removed to federal court, and granted the plaintiffs’ motion to remand the case back to state court.

The defendants had based arguments in support of removal on the Class Action Fairness Act of 2005, which provides that a state court class action is removable to federal court where the amount in controversy is greater than $5 million and any class member is a citizen of a state different than the defendant. The parties agreed that the conditions were met in this case. In seeking remand, the plaintiffs relied on the express provision of Section 22(a) of the Securities Act of 1933 that prohibits the removal from state court to federal court of an action under the ’33 Act.

In reliance on principals of statutory construction, Judge Pfaelzer concluded that the specific principals in the ’33 Act must control. She said that “the Court continues to harbor significant doubt that CAFA provides removal jurisdiction in the face of the 1933 Act’s absolute prohibition on removal. Accordingly, the Court must remand the case to state court.”

Given the language in Section 22(a), Judge Pfaelzer’s decision seems correct. However, the outcome seems undesirable. There is no way to know for sure why the plaintiffs’ lawyers seek to proceed in state court. As I discussed in my prior post, the likeliest explanation is that the plaintiffs intend to take the position that the provisions and requirements of the PSLRA do not apply to a ’33 Act case in state court. It certainly does seem like putting federal securities class actions in state court opens up a can of worms. It will be interesting to see (but difficult to track) what happens with these class action lawsuits.

Speakers’ Corner: On Friday, March 14, 2008, I will be participating in a webcast sponsored by RiskMetrics Group entitled “Securities Litigation – What European Investors Need to Know.” The panel will be moderated by Adam Savett, of the Risk Metrics Group and author of the Securities Litigation Watch blog. Also on the panel will be Eric Belfi of Labaton Sucharow and an additional guest speaker. Information regarding the webcast can be found here.

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