Section 10(b) of the Securities Exchange Act of 1934 permits an investor to bring a claim for securities fraud against a public company based on material fraudulent statements, including those made in financial report filings with the Securities and Exchange Commission. Section 10(b) has created the most common cause of action in U.S. federal courts for aggrieved investors to claim fraud and subsequent damages against a company issuing securities. A question with which federal courts have struggled is whether American courts are available to foreign investors seeking damages against issuers of shares traded on a foreign exchange. In a much awaited decision, Morrison et al., v. National Australia Bank Ltd. et al., No. 08-1191, the United States Supreme Court closed the debate regarding extraterritorial application of Section 10(b) of the Exchange Act. The Court held in late June that Section 10(b) does not provide a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges.
National Australia Bank (NAB) is an Australian bank whose common stock is traded on the Australian Stock Exchange and other foreign securities exachanges, but is not traded on any exchanges in the United States. In this case, NAB purchased a Florida loan servicing corporation, HomeSide Lending (HomeSide), in 1998. Three years later NAB wrote down the value of the HomeSide assets causing NAB’s share price to fall. Australian investors in NAB sued the bank and HomeSide in the Southern District of New York alleging violations of both Sections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5. See In re National Australia Bank Securities Litigation, No. 03 Civ. 6537 (BSJ), 2006 WL 3844465 (S.D.N.Y. Oct. 25, 2006). The Australian investors claimed that HomeSide and its officers had manipulated the valuation models to make HomeSide look more valuable than it really was, and that NAB was aware of this deception. The investors further alleged that between 1998 and 2001 NAB incorporated the deceptive and fraudulent valuation of HomeSide into NAB’s annual reports, other public filings, and public statements and that the investors relied on these fraudulent statements in purchasing NAB issued securities. After the defendants moved for dismissal, the District Court dismissed the case for lack of subject matter jurisdiction. The Second Circuit affirmed the District Court’s ruling and the Supreme Court granted certiorari to settle the long standing debate on whether Section 10(b) applies abroad.
The Court’s majority opinion, authored by Justice Scalia, began its analysis by stating the “longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.” The Court then describes how several U.S. Circuit Courts, most notably the Second Circuit, had deviated from the presumption against reading extraterritorial application of a statute, in connection with securities fraud claims, by reading several expansions into the text of Section 10(b). The Court rejected the Second Circuit’s extraterritorial expansion of Section 10(b) premised upon either some effect on American securities markets or investors (“effects test”), or significant conduct in the United States (“conduct test”). Morrison et al., v. National Australia Bank et al., Slip Opinion No. 08-1191 at p. 8. Stating that the language of Section 10(b) contains no indication of Congress’ intent that it apply abroad, the Court foreclosed future extraterritorial applications of Section 10(b). National Australia Bank at 16.
The Supreme Court rejected the Second Circuit’s reasoning underlying its extraterritorial Section 10(b) decisions. Instead, the Court adopted a “transaction test,” under which the Court held “it is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities to which §10(b) applies.” Id. at 18. In other words, “Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Id. at 24.
The Court’s decision in National Australia Bank clearly prohibits foreign investors, who purchase securities overseas, from asserting a claim under Section 10(b). What seems also true is that United States investors who purchase foreign issuers’ shares on a foreign exchanges are also foreclosed from pursuing claims under Section 10(b) because such transactions neither: (i) occurred on “domestic exchanges”; nor (ii) appear to qualify as “purchase[s] or sale[s] of any other security in the United States.”
While the Court’s decision does not expressly prohibit a United States investor from pursuing claims under Section 10(b) for transactions on foreign exchanges, Justice Stevens’s concurring opinion interprets the Court’s opinion as doing just that. Justice Stevens notes:
[i]magine, for example, an American investor who buys shares in a company listed only on an overseas exchange. That company has a major American subsidiary with executives based in New York City; and it was in New York City that the executives masterminded and implemented a massive deception which artificially inflated the stock price—and which will, upon its disclosure, cause the price to plummet. Or, imagine that those same executives go knocking on doors in Manhattan and convince an unsophisticated retiree, on the basis of material misrepresentations, to invest her life savings in the company’s doomed securities. Both of these investors would, under the Court’s new test, be barred from seeking relief under §10(b).
(Stevens, J. concurring op. at 12-13). While the Court questions many of the statements in Justice Stevens’ concurring opinion, it notably does not state that Justice Stevens misinterprets the Court’s holding on this point.
Thus, the question of whether a United States investor can pursue claims under Section 10(b) for securities purchased on foreign exchanges is still critically important to numerous currently pending securities class actions including those against Porsche, Vivendi, UBS, The Royal Bank of Scotland, and Toyota. Subsequent guidance on this and other issues will likely continue in coming terms.
If you have questions about this decision or how it may impact your business, please contact me or any member of Baker Hostetler’s Securities Litigation and Regulatory Enforcement Team.
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