It has been ten years since the U.S. Supreme Court issued its landmark opinion in Morrison v. National Australia Bank, in which the Court clarified that the U.S. securities laws applies only to securities transactions that take place in the United States, either on an exchange or otherwise. While the decision has had a significant impact on a wide range of cases, it has not yet “brought the predictability and consistency it promised” and it has “spawned a number of unintended consequences,” according to a recent memo from the Cleary Gottlieb firm. The September 24, 2020 memo, entitled “Foreign Securities Class Actions 10 Years After Morrison,” which details three specific problem areas that have emerged as the lower courts have interpreted and applied Morrison over the last decade, can be found here.

The Morrison decision overturned decades of case law in which the lower courts struggled to apply the then-applicable “conduct and effects” test to determine whether or not the U.S. securities were applicable in any given circumstance. In a decision written by the late Justice Antonin Scalia, the Court said in Morrison that the U.S. securities laws apply only to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities.”

The first prong of this standard has proven relatively straight forward. However, the second prong, pertaining to “domestic transactions,” has, according to the law firm memo’s authors, “proven considerably more difficult to apply.”

Three sets of recurring issues have developed as the courts have set about trying to interpret and apply Morrison’s second prong, according to the law firm memo’s authors.

The first of these issues is the question of what makes a transaction “domestic”?  As discussed here, in 2012, the Second Circuit issued what the law firm memo’s authors called “the most comprehensive analysis of Morrison’s second prong to date” in Absolute Activist Value Master Fund, Inc. v. Ficeto. The Second Circuit held 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 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.”

The Second Circuit’s decision in turn presents the question of where irrevocable liability occurs; in order to try to apply this standard, “courts have issued heavily fact-specific decisions necessarily limited to the particular cases and controversies before them.” At this point there are still only “very few clear rules and many unanswered questions” about what factors the courts consider to determine if a transaction occurred in the U.S. when it has many foreign and domestic elements. These issues are particularly challenging “given that transactions are often negotiated electronically in impersonal markets, either by parties located in different countries or by agents who locations may be unknown.”

The result is that even ten years after the Morrison decision, “courts have not provided significant guidance on the features that would render an off-exchange transaction domestic” for purposes of the determining the applicability of the federal securities laws. Instead, the courts have created “an unpredictable and inconsistent facts-and-circumstances test very much like the one that the Court rejected in Morrison.”

The second of three sets of issues that have arisen after Morrison has to do with transactions in which the issuers had little or no involvement, transactions that could subject the issuer to potential liability under the U.S. securities laws. The most significant example of this problem is the Toshiba securities case, in which, as discussed here, the Ninth Circuit held that the U.S. securities laws may apply to domestic transactions in unsponsored Level I American Depository Receipts.

The Ninth Circuit’s decision in the Toshiba case stands in contrast to the Second Circuit’s decision in Parkcentral Global Hub Ltd. v. Porsche Automobil Holdings SE, in which, as discussed here, the Second Circuit said that while it is necessary for the U.S. securities laws to apply that a domestic transaction is involved, it is not sufficient.  The court said that where the foreign issuer was not involved in an otherwise domestic transaction, the transaction was “predominately foreign” so as to be “impermissibly extraterritorial.”

At a minimum, these two decisions are sufficiently contrasting that they create a “circuit split” between the two courts. Of even greater concern, the Ninth Circuit’s decision in Toshiba leaves foreign companies “exposed to class action risk “ in the U.S., “even if they take no steps to access the U.S. market.”

Thus the law firm memo’s authors note, “notwithstanding Morrison’s stated concern about extending the U.S. securities laws to foreign fraud,” the Ninth Circuit’s decision in Toshiba “raises the prospect of imposing liability under the federal securities laws against foreign companies based on limited contacts with the U.S.” In light of these concerns and of the circuit split, Toshiba sought to have the U.S. Supreme Court take up these issues, however Supreme Court denied the company’s petition.

The third of the set of three post-Morrison issues had to do with claimants’ attempts to bring foreign law claims as “add-ons” to class actions under the U.S. securities laws in an attempt to “circumvent the territorial limitations” on the reach of the U.S. laws. The Toshiba case again presents an illustration of this problem. As discussed here, in January 2020, Central District of California Judge Dean Pregerson, in holding that in addition to the allowing the claims of the class of investors who purchased their Toshiba securities in the U.S. to go forward, also held that the separate liability claims against Toshiba under the Japanese securities laws can go forward as well, even though Japan does not have a class action procedure comparable to the U.S mechanism.

The law firm memo’s authors note that allowing these foreign law claims to go forward in U.S. courts would “threaten the very harm to foreign issuers that Morrison sought to foreclose.” Permitting these claims to proceed “effectively creates an exception to Morrison, as it reopens the U.S. courts to lawyers representing investors from around the world allegedly cheated in foreign securities markets.” It was one of Morrison’s “express aims” to “put an end to that practice.” Plaintiffs’ lawyers “may now be able to piggyback foreign law class claims” on to a U.S. securities class action lawsuit, which “substantially magnifies the risk” that foreign companies may not only be at risk of being held liable in connection with domestic U.S. securities transactions, but also for “foreign claims under foreign law, even if the foreign law does not provide a plaintiff with the same class action mechanism.”

Discussion

Since the U.S. Supreme Court first issued the Morrison decision ten years ago, it has continued to be a source of discussion and concern, both between and among practitioners and observers within the U.S. and also between and among practitioners and observers outside the U.S. as well. As the law firm memo’s authors note, as the case law interpreting Morrison has developed, it has become increasingly difficult to know for sure whether or not a non-U.S. company might be hauled into U.S. court and held subject to U.S. laws.

I know from many discussions that non-U.S. practitioners find the Ninth Circuit’s decision in Toshiba is particularly confusing and vexing; these observers find it very hard to understand how Toshiba could be held subject to the U.S. securities laws when it did not even sponsor the Level I ADRs involved in the securities class action lawsuit. The company did not purposely avail itself of the opportunity to have its securities trade in the U.S, so how could it be subject to liability under the U.S. securities laws? I understand their concern but as I have also pointed out to them, if the U.S. securities laws do not apply to domestic U.S. transaction in the ADR securities, what jurisdiction’s law does apply? These concerns and questions simply underscore how challenging some of these issues are.

It is of particular concern that as the case law has developed, the possibility that foreign companies could find themselves exposed to liability exposures under the U.S. securities laws seems to have grown in ways that seem to be directly contrary to the very purposes of the Morrison decision. The possibility that non-U.S. companies could be subject to liability action in U.S. courts for claims based on alleged violation of their home country’s laws is particularly troublesome, particularly where their home country’s laws do not provide for class action procedures of the type available in the U.S.

While these various developments are, as the law firm memo’s authors note, inconsistent with the spirit of Morrison, it seems unlikely that the U.S. Supreme Court will take up these issues any time soon. The Court’s denial of the Toshiba’s cert petition would seem to suggest that the possibility of having the Supreme Court revisit these issues is, for now at least, remote.

It is worth noting that for most of the past ten years, the cost of D&O insurance for non-U.S. companies potentially exposed to U.S. securities litigation claim was lower than the cost of D&O insurance for domestic U.S. companies. I believe that in part this pricing differential was the result of an underappreciation of the extent to which the non-U.S. companies potentially could be subject to U.S. claims. In more recent periods, the pricing for non-U.S. companies’ D&O insurance has begun to increase sharply, in some cases by greater percentages that the increases that domestic U.S. companies are facing. These sharp increases are in part a reflection of the fact that the question of the possibility for non-U.S. companies to face securities claims in the U.S. is troublingly difficult to assess, for reasons discussed above. The unclear state of the case law post-Morrison is one of the many factors currently roiling the D&O insurance market for non-U.S. companies.

The law firm memo’s authors do not mention it, but Morrison has also had an important role to play in the development of collective securities litigation outside the U.S.  Foreign investors who prior to Morrison might have sought to access U.S. courts in order to assert their claims have found themselves attempting to seek redress in the courts of their home jurisdictions, asserting claims under the home jurisdiction’s laws. The courts of several jurisdictions (for example, Canada and The Netherlands) have expressly cited Morrison and the consequent lack of access to U.S. courts as reasons for those non-U.S. courts to consider in deciding whether or not to take up the claims of aggrieved investors.