In the latest demonstration of just how far the U.S.
Supreme Court's holding in Morrison v. National Australia Bank may restrict
Section 10(b) claims involving foreign companies, on December 30, 2010,
Southern District of New York Judge Harold Baer held that U.S.-based hedge
funds could not pursue the claims that Porsche and certain of its officers had
misrepresented Porsche's intent to take over Volkswagen, which the hedge funds
claim put them in a "short squeeze" that cost them $2 billion.
A copy of Judge Baer's December 30 ruling in the Porsche
case can be found here.
Background
The plaintiff hedge funds had entered security based swap
agreements that referenced the price of VW shares. The swaps did not trade on
any exchanges. The swap agreements generated gains for plaintiffs as VW's
shares decline and produced losses as the price of VW shares rose.
The plaintiffs allege that all of the steps necessary to
transact the swap agreements were carried out in the United States. The swap
agreements contain choice of law and forum selection provisions designated New
York law and a New York forum.
In the lawsuits, the hedge fund plaintiffs allege that
the defendants had caused a dramatic rise in VW stock prices by buying nearly
all of the few freely-traded shares as part of a secret plan to take over the
company. The plaintiffs allege that after months of denying that it sought to
take over VW, Porsche on October 26, 2008 disclosed the extent of its accumulated
holdings in VW stock, as a result of which the VW share price shot up, causing
the plaintiffs losses on their share agreements.
The defendants moved to dismiss in reliance on Morrison,
on the grounds that the transaction was not within the ambit of Section 10(b)
of the Securities Act of 1934.
The December 30 Holding
Morrison had held that Section 10(b) applies only to
"transactions in securities listed on domestic exchanges, and domestic
transaction in other securities." Because the plaintiffs' swap agreements
do not trade on U.S. exchanges, the relevant inquiry, according to Judge Baer,
is whether the swap agreements constitute "domestic transactions in other
securities."
The plaintiffs argued that because they signed
confirmations for securities-based swap agreements in New York, they engaged in
"domestic transactions on other securities" within the scope of
Section 10(b).
Judge Baer held that these arguments were
"inconsistent" with the "Supreme Court's intention" to
"curtail the extraterritorial application of Section 10(b)." He added
that if the argument were allowed, it "would extend extraterritorial
application of the Exchange Act's antifraud provisions to virtually any
situation in which one party to a swap agreement is located in the United
States."
Judge Baer found this situation to be indistinguishable
from one in which a U.S.-based investor bought securities in a non-U.S. company
on a foreign exchange, circumstances that other courts previously have held to
be outside the ambit of Section 10(b) in the wake of Morrison.
Looking to what he described as the "economic
reality" of the swap transaction, Judge Baer found that "Plaintiffs'
swaps were the function equivalent of trading the underlying shares on a German
exchange," noting that "the swap agreements were transacted with
undisclosed counterparties who may well have been located outside the United
States," and that both the issuer and the perpetrator of the alleged fraud
were also located outside the United States.
Judge Baer noted that he is "loathe to create a rule
that would make foreign issuers with little relationship to the U.S. subject to
suits here simply because a private party in this country entered a derivatives
contract that references the foreign issuer's stock. Such a holding would turn
Morrison's presumption against extraterritoriality on its head."
Discussion
Perhaps the most telling line in Judge Baer's opinion is
his statement that the U.S. Supreme Court's intention in Morrison had been to
"curtail the extraterritorial application of Section 10(b)," Clearly,
that has been the lower courts' approach, effectively "curtailing"
the reach of Section 10(b) in a wide variety of circumstances.
With this presumption about Morrison's intention
as his starting point, Judge Baer seems very clear that the swap transaction at
issue here did not satisfy the Morrison "domestic transaction" test.
But while the mere U.S. location of one swap counterparty may not be sufficient
to subject a foreign-domiciled issuer to U.S securities laws, Judge Baer's
analysis still does beg several questions left unanswered in his opinion,
namely: if this transaction is not a U.S. "domestic transaction," of
what jurisdiction is it a domestic transaction? If the transaction details here
are not sufficient to constitute a "domestic transaction," what
transaction details are sufficient?
It remains for other courts to work through these kinds
of questions. In the meantime, Judge Baer's analysis, if followed by other
courts, could restrict other prospective plaintiffs' ability to rely on
Morrison's second prong to try to bring Section 10(b) claims involving foreign
companies. Judge Baer's analysis, along with that of other courts, suggests
that courts will take a narrow view of what constitutes a "domestic
transaction in other securities."
Certainly, a court proceeding, as did Judge Baer, on the
assumption that Morrison intended to "curtail the extraterritorial
effect of Section 10(b)" arguably will be predisposed against finding that
a transaction involving a foreign company's securities not traded on U.S.
exchanges is a "domestic transaction in other securities." Morrison's
second prong may not prove to be as valuable to plaintiffs as they initially
thought it might.
Allison Frankel's January 3, 2011 Am Law Litigation
Daily article about the Porsche decision can be found here.
Special thanks to the several readers who provided me
with copies of Judge Baer's opinion.
Read
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
For more information:
Liability
under Section 10(b) and Rule 10b-5 is discussed in greater detail in 1 A.A.
Sommer Jr., Federal Securities Exchange Act of 1934 § 5.04 (Matthew Bender
Rev. Ed.), "Implied Civil Liabilities under Section 10(b) and Rule
10b-5," which can be accessed online by subscribers of lexis.com. This
treatise is also available on the LexisNexis online store.