It has been over ten years since the U.S. Supreme Court issued its landmark decision in Morrison v National Australia Bank – yet the lower courts continue to struggle with its application in specific situations. Morrison clarified that the U.S. securities laws apply to securities transactions on U.S. securities exchanges and to domestic transactions in other securities. It is Morrison’s second prong, relating to domestic transactions in other securities, that continues to vex the courts.

In a recent decision, the Second Circuit affirmed a district court’s dismissal of a securities lawsuit on the grounds that the underlying securities transaction, even if domestic, was so “predominantly foreign” as to be “impermissibly extraterritorial.” As discussed below, the Second Circuit’s decision underscores an ongoing question of how far beyond Morrison’s “domestic transaction” question courts should go in determining whether U.S. securities laws apply to a transaction. The Second Circuit’s January 25, 2021 decision in Cavello Bay Reinsurance Ltd v. Stein can be found here.

Background

This lawsuit arises out of a private offering in which a Bermudian corporation bought shares in a Bermudian holding company that operates in New York and that invests in U.S. insurance services companies. The buyer subsequently alleged that the seller had misrepresented its fee structure. The buyer filed a lawsuit in federal district court in Manhattan alleging violations of the U.S. securities laws.

The defendant moved to dismiss the plaintiff’s complaint in reliance on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank. Because the securities in question did not trade on a U.S. securities exchange, the defendant’s motion to dismiss was based on Morrison’s “second prong” – that is, on the ground that the transaction in question did not involve a domestic transaction in other securities.

The district court granted the defendant’s motion to dismiss on two grounds: first, that the parties’ transaction was not “domestic”; and second, that even if the parties’ transaction was domestic, the transaction was “so predominantly foreign” as to be “impermissibly extraterritorial.” In reaching the second conclusion, the district court relied on the Second Circuit’s 2014 decision in Parkcentral Global HUB Ltd. v. Porsche Automobile Holdings SE (discussed here). The plaintiff appealed the dismissal.

The January 25, 2021 Opinion

In a January 25, 2021 opinion written by Judge Dennis Jacobs for a unanimous three-judge panel, the Second Circuit affirmed the district court’s dismissal. In reaching this decision, the appellate court was willing to assume that the transaction was domestic, but nevertheless affirmed the district court on the grounds that the plaintiff’s claims are so “predominately foreign” as to be impermissibly extraterritorial under the Parkland decision.

With respect to the threshold question whether the underlying transaction was “domestic,” the appellate court noted that the “transaction arguably took place in the United States.” The plaintiff had contended that the transaction agreement became binding when it was signed in New York, while the defendant had argued that it became binding under New York law only when it was sent to Bermuda and signed there.

The appellate court observed that “the particulars of this case illustrate how the ‘meeting of the minds’ can be arranged or confused by the parties, or can become enmeshed in contract law,” adding that “the place of the transaction is difficult to locate and impossible to do so without making state law.” For that reason, the appellate court said, “we assume, without deciding, that the parties’ transaction was domestic.”

In affirming the district court in reliance on the Parklcentral decision on the grounds that the transaction, even if domestic, was so predominately foreign as to be impermissibly extraterritorial, the court noted that the Parkland standard “is a gloss on Morrison’s rule.” Under Morrison, the “focus” of the federal securities laws is upon “purchases and sales of securities in the United States,” and not the place where the alleged deception originated. If the “focus” occurred in a “foreign country, then the case involves an impermissible extraterritorial application regardless of any other conduct that occurred in the U.S.” Under Parkcentral, even if a transaction occurs in the United States, the features and incidents of the transaction may be so foreign that it is not regulated by the U.S. securities laws. Parkcentral, the appellate court said, “flexibly considers whether a claim – in view of the security and transaction as structured – is still predominantly foreign.”

With this background, the appellate court rejected the factors on which the plaintiff tried to rely in arguing that the transaction was not predominantly foreign. The transaction agreement had a provision requiring the seller to register the securities with the SEC (or meet an exemption) should the buyer wish to resell the securities. The appellate court said this was a “mere contractual impediment to resale, conditioning resale on the invocation of U.S. law” The plaintiff “provides no reason to think an SEC registration requirement – contingent and future triggers some U.S. interest.” The appellate court added that the designation of New York law as controlling as “neither here not there.”

Most of the other ground on which the plaintiff relies, the appellate court said, are “vestiges” of the “now-defunct conduct and effects test” that Morrison replaced. The existence of various contacts with U.S. territory does not suffice, as the “contacts that matter are those that relate to the purchase and sale of securities.”

The appellate court went on to note that the plaintiff seeks access to a “domestic forum and judicial resources” but the transactions “is structured to avoid the bother and expense (and taxation) of U.S. law.” If the “sophisticated” parties had wanted the regulatory hand of U.S. law, “they could have bargained for it and structured a U.S. transaction, but instead the transaction “implicates only the interests of two foreign companies and Bermuda.” Providing a domestic forum “ought to enhance confidence in U.S. securities markets or protect U.S. investors” – here “it would do neither.”

Discussion

As Jonathan Richman of the Proskauer law firm noted in his January 26, 2021 memo about the Cavello Bay decision (here), the Second Circuit’s decision “does not break new ground.” The ruling is in effect another reminder that under Morrison the focus of a court’s inquiry in deciding whether the U.S. securities laws apply is on the transactional allegations, not on the allegations concerning the underlying fraud.

Just the same, the Second Circuit’s focus on whether or not the transaction is, even if domestic, still “predominantly foreign” does, as Richman notes, “underscore the existing tension” between Second Circuit case law and the Ninth Circuit’s 2018 decision in Stoyas v. Toshiba Corporation.

As discussed here, in its July 2018 decision in the Toshiba case, the Ninth Circuit rejected the defendants’ efforts to rely on the Second Circuit’s decision in Parkcentral to try to argue that the U.S. transactions in Toshiba’s unsponsored Level I ADRs were nevertheless “predominantly foreign.” The Ninth Circuit said in the Toshiba case that Parkcentral is distinguishable on numerous factual grounds, adding that the principal reason it could not follow Parkcentral is that “it is contrary to Section 10(b) and Morrison itself.” Parkcentral’s test for whether a claim is “so predominately foreign as to be impermissibly extraterritorial” is an “open-ended, under-defined, multi-factor test, akin to the vague and unpredictable tests that Morrison criticized and endeavored to replace.” The appellate court noted in a footnote that no Second Circuit case, nor any other circuit, has applied Parkcentral’s rule.

Indeed, when Toshiba filed a petition for a writ of certiorari to the U.S. Supreme Court, seeking to have the Supreme Court review the Ninth Circuit’s decision, the company argued that the Court should take up the case in order to address the split between the circuits on the question of whether courts may go beyond the determination that a transaction was domestic as to make the application of the U.S. securities laws impermissibly extraterritorial.

The Supreme Court denied Toshiba’s petition, possible on the grounds that the case was not procedurally teed up the right way. Whatever the reason, the Supreme Court declined to take up the issue, leaving unexamined the discernable difference in approach between the Ninth Circuit and the Second Circuit. As Richman’s memo notes, the Ninth Circuit considers the question of the existence of a domestic transaction as the end of the Morrison inquiry, rather than a “threshold requirement,” without room for further analysis of “predominant foreignness” considerations that the Second Circuit considered under the Parkcentral and the Cavello Bay.

Richman’s memo does note that the Ninth Circuit shifted consideration of some of these issues to Section 10(b)’s separate requirement that the alleged fraud must have occurred “in connection with” the purchase or sale of securities.

Just the same, it seems to be that sooner or later the Supreme Court is going to have to take up these issues and consider whether or not the Morrison standard does or does not permit or require the “predominant foreignness” analysis that the Second Circuit added as a “gloss” on the “domestic transaction” requirement.

It does seem to me that there is some truth to the Ninth Circuit’s observation that the “predominant foreignness” analysis under Parkcentral does re-introduce the very kind of open-ended, under-defined multi-factor test that Morrison sought to eliminate. As the Second Circuit said in Cavello Bay, the Parkcentral test does introduce some “flexibility” – but is flexibility what the Supreme Court had in mind when it sought to impose a bright-line test in Morrison?

It also seems to me that in the Cavello Bay decision the Second Circuit seized on the “predominant foreignness” analysis as a way to avoid having to do the hard work of figuring out whether or not the underlying transaction was “domestic.” It is almost as if the appellate court – when it said that the “place of the transaction is difficult to locate, and impossible to do without making state law” – was happy to seize on an alternative approach that would not require the court to perform the very analysis that Morrison requires. As I read Morrison, it is not an option for courts to sidestep the question of whether a transaction is domestic; to the contrary, that is the essence of the inquiry the court must perform.

In the end. I believe the real explanation for the Second Circuit’s ruling in the Cavello Bay case is to be found in the appellate court’s commentary on whether or not the parties before the court ought to be able to command the time, attention, and resources of a U.S. court. Regardless of what Morrison may or may not require, the appellate court seems to be saying that the resources of U.S. courts ought not to be taken up with a dispute between two Bermudian companies that were involved with a transaction that was structured to avoid “ the bother and expense (and taxation) of U.S. law.” I can certainly understand the court’s point of view. But it still leaves me with the question of what Morrison requires.