The U.S. Supreme Court's decision in Morrison v. National Australia Bank presents significant obstacles for claimants who want to pursue securities claims against non-U.S. companies in the U.S courts, as the short sellers who tried to sue Porsche in the Southern District of New York found out-their prior federal court securities suit was dismissed on the basis of Morrison. However, the short-sellers' state court common law claims will now be going forward, as a result of a recent New York state court decision that may suggest one way that litigants may be able to avoid Morrison's constraints.
On August 6, 2012, New York (New York County) Supreme Court Judge Charles E. Ramos rejected Porsche's motion to dismiss the case on forum non conveniens ground. A copy of Judge Ramos's decision can be found here.
As discussed here, the plaintiffs in the federal court suit -- hedge fund investors who lost money short-selling shares of German auto manufacturer VW -- allege that during 2008, Porsche and certain of its executives made a series of misrepresentations in which Porsche claimed that it did not intend to acquire control of VW, while at the same time it allegedly was secretly accumulating shares with the purpose of obtaining control. In October 2008, after Porsche disclosed its intent to obtain control, VW's share price rose significantly and the short sellers suffered significant trading losses.
The short-sellers federal court complaint asserted claims under the U.S. securities laws and also for common law fraud. As discussed here, on December 30, 2012, Southern District of New York Judge Harold Baer dismissed the securities claims on the grounds that the subject transactions, securities-based swap agreements, represented a foreign transaction and are therefore not within the purview of the U.S. securities laws. Judge Baer declined to exercise supplemental jurisdiction over the common law claims. Judge Baer's ruling is now on appeal to the Second Circuit.
In March 2011, several of the same short sellers launched a separate action in New York Supreme Court against Porsche alleging claims for fraud and unjust enrichment. Porsche moved to dismiss the state court complaint on the grounds of forum non conveniens and for failure to state a claim. Porsche also moved in the alternative to stay the state court action pending the outcome of the Second Circuit appeal in the federal court action.
In his August 6 order, Judge Ramos denied Porsche's motion. First, Judge Ramos held that "a balancing of the relevant factors reveals that Porsche has not met the heavy burden of demonstrating that this action should be dismissed on the ground of forum non conveniens." In reaching this conclusion, he noted that the plaintiffs are located in New York; that Porsche allegedly made multiple misrepresentations directly to the plaintiffs in New York; that Porsche representatives transmitted multiple communications to the plaintiffs and others in New York; and that the five principal plaintiffs' witnesses are all located in New York.
He also noted that though many critical witnesses reside in Germany, "large corporations such as Porsche with ample resources have minimal difficulty bringing foreign witnesses or documents to New York Court," and that the company regularly transacts business in the U.S.
Finally, Judge Ramos rejected Porsche's "characterization" of the case as alleging "the manipulation of the German stock market and the trade of German securities"; rather, the question is whether New York courts "may hold responsible a foreign entity, who conducts business globally, for fraudulent misrepresentation purportedly aimed at New York plaintiffs." New York "clearly has a vested interest in such an action."
Judge Ramos also concluded that the plaintiffs had adequately stated claims for fraud and for unjust enrichment, and he declined to stay this action pending the outcome of the federal court appeal.
The outcome of Judge Ramos's decision is obviously interesting in and of itself, but it is also particularly interesting in light of the fact that the prior federal securities lawsuit was dismissed on the basis of the Morrison decision. These plaintiffs, stymied by Morrison in their attempt to assert federal securities claims, have nonetheless managed to find a way to pursue claims against the non-U.S. defendant in U.S. court, by asserting common law claims that are not subject to Morrison's constraints.
These plaintiffs ability to pursue their claims against Porsche in a U.S. court may suggest ways that other prospective claimants might be able to circumvent Morrison's constraints and to pursue misrepresentation claims in U.S. courts against non-U.S. companies.
However, there are things that may constrain other prospective claimants from pursuing a similar strategy. For starters, the plaintiffs in this case were only successful in avoiding a forum non conveniens dismissal because of the case-specific factors that tied the case and the underlying circumstances to New York. Other prospective claimants may or may not be able to marshal equally compelling evidence of a connection to a U.S. jurisdiction.
The other thing that may make this case somewhat distinct is that many of the alleged misrepresentations on which the plaintiffs relied allegedly were made directly to them by Porsche's representatives. The existence of these direct misrepresentations significantly boosted the plaintiff's ability here to assert claims for common law fraud - and more particularly to be able to establish the critical element of reliance. (Alison Frankel has a particularly good explicatioin of Judge Ramos's considertion of the reliance issue in an August 9, 2012 post on her On the Case blog, here.) Other litigants, perhaps relying on market-wide statements, may be less able to show all of the elements necessary to raise claims for common law fraud or other common law claims.
But while there undoubtedly are considerations that may complicate matters for other prospective claimants who want to pursue misrepresentation claims against non-U.S. companies, this case nevertheless does show at least a possible way to pursue those claims in U.S. courts without the constraints of the Morrison decision. It should no noted that, according to David Bario's August 9, 2012 article in the Am Law Litigation Daily about Judge Ramos's ruling (here) , the defendants apparently intend to pursue an appeal of the ruling.
While the Second Circuit appeal in the federal court case remains pending, on March 1, 2012 the Second Circuit did release its opinion in the Absolute Activist Value Master Fund decision, which provided significant interpretation of Morrison and, as discussed here, could have a substantial impact on the appeal in the Porsche case.
Yet another alternative for investors who want to pursue claims against Porsche would be to sue them in the company's home country courts - which is what at least some investors have done. As discussed here, other investors have also initiated an action against Porsche in Stuttgart based on the same allegations.
Perhaps the Chinese Reverse Merger Company Cases Have Legs After All: Maybe the plaintiffs will be able to make something out of the wave of lawsuits against U.S.-listed Chinese companies after all. Last week, the Second Circuit revived the suit against China North Petroleum Holdings, which the district court had dismissed. And on August 8, 2012, Southern District of New York Judge Katherine Forrest denied the motion to dismiss the securities class action lawsuit that had been filed against China Automotive Holdings. A copy of Judge Forrest's opinion can be found here.
China Automotive Holdings obtained its U.S. listing as a result of a reverse merger. As detailed here, the plaintiff shareholders first filed their action in October 2011, alleging that the company had misrepresented its financial condition by accounting improperly for certain convertible notes, which had the effect of overstating the company's earnings. The company ultimately replaced its auditor and restated its financial statements for prior periods in order to properly account for the convertible notes. During the class period the individual defendants collectively sold over $40 million of their personal holdings in company securities. The defendants include the company, certain of its directors and officers, and the company's prior auditor. The company and the auditor moved to dismiss. (The individual defendants have not yet been served and have not appeared in the case.)
In her August 8, 2012 opinion, Judge Forrest denied the company's motion to dismiss but granted the auditor's motion (with leave to amend).
In denying the company's motion, Judge Forrest rejected two substantial arguments that the company had raised; first, the company had argued that because almost all of the insider sales on which the plaintiff relied were made pursuant to a Rule 105-1 trading plans, the plaintiffs cannot rely on the trades in order to establish scienter; and the company argued that the plaintiffs cannot establish loss causation, because the decline in the company's share price was attributable to the market's loss of confidence in the Chinese Reverse merger companies.
In rejecting the company's arguments that the insider sales were made pursuant to Rule 10b5-1 trading plans, Judge Forrest found that because the trading plans were entered during the class period, they "are not a cognizable defense to scienter allegations on a motion to dismiss."
And in rejecting the argument that the plaintiffs have not established loss causation because the decline in the company's share price was due to marketplace concerns about Chinese reverse merger companies, Judge Forrest noted that "although Chinese Reverse Merger companies have faced 'public scrutuny' ... to hold that plaintiffs failed to plead loss causation solely because other Chinese Reverse Merger Companies' stock dropped contemporaneously with [the company's] stock price decline would place too much weight on one single factor."
Judge Forrest holding with respect to the Rule 10b5-1 trading plans is interesting. These kinds of plans can serve as a basis for the dismissal of a securities fraud lawsuit (refer for example here). However, these kinds of plans can be abused; indeed, Angelo Mozillo's notorious alleged manipulation of his Rule 10b5-1 trading plan was a significant feature of the Countrywide securities class action lawsuit (about which refer here). In the present case, the timing of the individual defendants' plans undercut the company's ability to rely on the plans' existence to rebut the inference of scienter.
Judge Forrest's loss causation ruling is also interesting and may be useful for other plaintiffs in cases involving Chinese Reverse Merger companies. Many of these companies also experienced a significant share price decline because of the market's suspicion about these kinds of companies. Judge Forrest's ruling that the mere fact that there has been a marketplace decline does not alone undercut loss causation could be relevant in many other cases, particularly those cases that were filed after the general marketplace concerns had already emerged.
Though the plaintiffs have survived the initial pleading hurdle they may yet have a challenging road ahead. The fact that the individual defendants have not yet been served or entered an appearance gives a glimpse of the logistical, practical and procedural challenges the plaintiffs may face as they try to move this case forward. Among other things, they may face challenges in trying to get a class certified, as has proven to be the case in a least one other lawsuit involving a U.S.-listed Chinese company (about which refer here). And even claimants that have managed to get their suits against U.S.-listed Chinese companies all the way to the settlement stage have found that they often are forced to accept only modest settlements, often because the Chinese companies carry only very modest levels of D&O insurance (about which refer here).
But from the plaintiffs' perspective, the important thing now is they have survived the initial pleading threshold and will now be taking the case forward. There were many of these cases involving U.S.-listed Chinese companies filed in 2010 and 2011, and they will be interesting to watch. At least recently, it seems that the cases have been faring better than I had anticipated. Stay tuned for further developments, though.
Jan Wolfe's August 8, 2012 Am Law Litigation Daily article about the China Automotive case can be found here.
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.
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