On August 30, 2013, the United States Court of Appeals for the Second Circuit unanimously held that Section 10(b) of the Securities Exchange Act of 1934 (“Section 10(b)”) does not apply to extraterritorial conduct, “regardless of whether liability is sought criminally or civilly.” Interpreting the scope of the Supreme Court’s landmark ruling in Morrison v. National Australian Bank Ltd.,  the Second Circuit’s significant decision in United States v. Vilar, et al. means that a criminal defendant may be convicted of fraud under Section 10(b) only if the defendant engaged in fraud “in connection with” a security listed on a United States exchange or a security “purchased or sold” in the United States. In reaching its conclusion, the court rejected the government’s attempts to distinguish criminal liability under Section 10(b) from the civil liability at issue in Morrison, holding that “[a] statute either applies extraterritorially or it does not, and once it is determined that a statute does not apply extraterritorially, the only question we must answer in the individual case is whether the relevant conduct occurred in the territory of a foreign sovereign.”
Posts Tagged ‘Extraterritoriality’
On April 17, 2013, the Supreme Court issued its decision in Kiobel v. Royal Dutch Petroleum Co., __ U.S. __ (2013), addressing the scope of the Alien Tort Statute, 28 U.S.C. § 1350 (“ATS”). In Kiobel, the Court sharply limited the availability of U.S. courts to hear claims brought by foreign nationals against other foreign nationals for human rights violations committed outside the United States. Although the decision was unanimous, the Justices’ reasoning divided. Chief Justice Roberts, writing for the Court, concluded that the presumption against extraterritoriality applies to claims under the ATS and that nothing in the ATS itself rebuts that presumption. The Chief Justice’s opinion, joined by Justices Alito, Kennedy, Scalia, and Thomas, casts doubt on the viability of ATS claims arising from foreign acts, but leaves open the possibility that the presumption against extraterritoriality might be rebutted if claims “touch and concern the territory of the United States” with “sufficient force to displace” that presumption. A foreign defendant’s “[m]ere corporate presence” in the United States, however, does not suffice. Justice Breyer, joined by Justices Ginsburg, Sotomayor and Kagan, filed a concurrence in the judgment rejecting the application of the presumption against extraterritoriality and instead proposing that claims for violations of international law can be recognized under the ATS even for violations committed abroad either where the defendant is an American national or where the case sufficiently implicates a U.S. interest.
The Court’s analysis in Kiobel will likely have far-reaching repercussions for foreign nationals alleging that they have been the victims of human rights abuses outside the United States, for corporations potentially subject to expensive and difficult-to-predict ATS suits, and for foreign countries whose policies and actions might become the subject of ATS suits.
The Volcker Rule, as embodied in the Dodd-Frank Act and reflected in proposed regulations, generally prohibits “banking entities” from engaging in proprietary trading and from investing in or sponsoring private equity and hedge funds.  These “banking entities” include foreign banks that maintain branches or agencies in the U.S. or that own U.S. banks or commercial lending companies in the United States. These banks, as well as their parent holding companies, are referred to in U.S. regulations as “foreign banking organizations,” or “FBOs,” and we will use this term throughout this paper.  This bulletin evaluates how Volcker, as construed by proposed regulations, impacts the proprietary trading and investment fund-related activities of FBOs outside the United States.
Generally, the Dodd-Frank Act exempts proprietary trading by FBOs that is conducted solely outside the United States, and, provided that no ownership interest in a fund is offered or sold in the United States, investment fund-related activities by FBOs conducted solely outside the United States. The exemptions are available under the Dodd-Frank Act for FBOs (or their affiliates) not controlled by U.S.-based banking entities as long as the activities in question are conducted consistent with the exemption accorded FBOs for activities conducted outside the United States pursuant to Sections 4(c)(9 ) or 4(c)(13) of the Bank Holding Company Act. Accordingly, the exemptions are not available for activities conducted by the U.S. branches or agencies of FBOs, or by U.S. banks or U.S. commercial lending companies owned by FBOs.
Recently, in Global Reinsurance Corp.–U.S. Branch v. Equitas Ltd., the New York Court of Appeals, New York’s highest court, refused to apply the state’s antitrust statute, the Donnelly Act, to allegedly anticompetitive conduct in Great Britain that had only incidental effects in New York. Reversing a divided decision of the intermediate appellate court, the Court of Appeals reasoned that state antitrust law could not have a broader extraterritorial reach than federal antitrust law; otherwise, statutory and judicial limitations on the federal Sherman Act “would be undone if states remained free to authorize ‘little Sherman Act’ claims that went beyond it.”
This rationale may have significant implications beyond the antitrust arena, as the Court of Appeals more broadly reaffirmed that “[t]he established presumption is, of course, against the extra-territorial operation of New York law.” For example, the potential impact on securities claims under state common law is particularly notable. In the wake of the United States Supreme Court’s decision in Morrison v. National Australia Bank, which held that Section 10(b) of the Securities Exchange Act applies only to domestic securities transactions (see our memo here), a number of plaintiffs have attempted to invoke state common law to recover losses on extraterritorial transactions. One potential obstacle to such state-law suits appeared to have been removed late last year, when the Court of Appeals, in Assured Guaranty (UK) Ltd. v. J.P. Morgan Investment Management, rejected a line of lower-court and federal precedents that had held common-law securities actions preempted by New York’s securities statute, the Martin Act (see our memo here).
In its 2010 decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), the Supreme Court addressed whether Section 10(b) of the Securities Exchange Act applies to a securities transaction involving foreign investors, foreign issuers and/or securities traded on foreign exchanges. The Morrison decision curtailed the extraterritorial application of the federal securities laws by holding that Section 10(b) applies only to (a) transactions in securities listed on domestic exchanges or (b) domestic transactions in other securities.
In Absolute Activist Value Master Fund Ltd. v. Ficeto, et al., Docket No. 11-0221-cv (2d Cir. Mar. 1, 2012), the Second Circuit addressed for the first time what constitutes a “domestic transaction” in securities not listed on a U.S. exchange. The Court held that, to establish a domestic transaction in securities not listed on a U.S. exchange, plaintiffs must allege facts plausibly showing either that irrevocable liability was incurred or that title was transferred within the United States.
Plaintiffs in Absolute Activist were nine Cayman Island hedge funds (the “Funds”) that had engaged Absolute Capital Management Holdings (“ACM”) to act as their investment manager. Plaintiffs alleged in their complaint that the ACM management defendants engaged in a variation of a pump-and-dump scheme. Specifically, defendants were alleged to have caused the Funds to purchase billions of shares of U.S. penny stocks issued by thinly capitalized U.S. companies – stocks that defendants themselves also owned – and then to have traded those stocks among the Funds in a way that artificially drove up the share value. Defendants thereby were alleged to have profited both from the fees generated through the fraudulent trading activity and the profits they earned when they sold their shares of the penny stocks at a profit to the Funds.
Recently, the Amsterdam Court of Appeal issued an important decision in the Converium case with implications for class action suits in the United States and internationally. The decision authorizes the use of the Dutch collective-settlement statute to settle disputes on a classwide, opt-out basis. Given that the U.S. Supreme Court’s decision in Morrison v. National Australian Bank significantly limited the extent to which claims by foreign investors can be settled in United States securities cases, the Amsterdam Court of Appeal’s decision is significant because it provides a practical mechanism for structuring global securities class action settlements through the use of the Dutch statute in concert with U.S. proceedings, particularly in cases involving a large number of European investors.
Key developments in both the litigation and regulatory context are compelling multinational corporations to reassess their global securities litigation and regulatory compliance strategies. In the litigation context, recent U.S. Supreme Court activity has limited the ability of overseas plaintiffs to bring securities class action claims within the United States. As such, plaintiffs have shifted litigation to more flexible jurisdictions in Europe and overseas, thereby forcing global firms listed on multiple exchanges to increasingly defend against securities class action claims and regulatory investigations in numerous jurisdictions. At the same time, governments around the world have responded to the recent financial crisis by bolstering their regulatory capability. Governments have not only adopted more robust legislative regimes with respect to securities regulation, but they have also invested heavily in stronger enforcement protocols.
European and US market participants are having to prepare for the introduction of OTC derivatives legislation and clearing reforms, despite continuing uncertainty about the exact nature of significant elements of the new rules. Given the ‘sea of change’ engulfing the sector it’s important to focus on the practical effects of new regulation from a clearing member or market participant perspective.
Mapping the ‘sea of change’
Before going into any detail on individual areas of concern, it is worth very briefly sketching out the regulatory framework. In the US, the mechanism for implementing OTC derivatives regulations and clearing reforms is contained in the Dodd-Frank Act, while in Europe, the main legislation is the European Market Infrastructure Regulation (EMIR – as below), supported by further reforms in the Markets in Financial Instruments Directive (MiFID) and the Capital Requirements Directive 4 (CRD4). These changes are in response to the financial crisis, which highlighted a lack of information on positions and exposures of individual firms in OTC derivatives. This issue was seen to have prevented regulators from getting a clear view of the inherent risks building up in the system. It was also judged to have impeded accurate assessment of the consequences of a default and, as described by a recent European Commission impact assessment, “helped fuel suspicion and uncertainty among market participants during a crisis”.
In June 2010, in Morrison v. National Australia Bank, the U.S. Supreme Court held that U.S. securities antifraud laws do not reach transactions by non-U.S. investors in securities of non-U.S. companies effected on non-U.S. exchanges, even if the investors claim that their losses arose from conduct in the United States. In its decision, which overturned the so-called “conduct” and “effects” tests previously followed by U.S. courts, the Supreme Court adopted a “transactional” test for determining the territorial scope of the U.S. securities laws. In rejecting the efforts of the plaintiffs’ bar to end-run Morrison, lower federal courts have applied the Supreme Court’s reasoning to avoid the extraterritorial application of the U.S. securities laws. Most notably, in separate securities fraud actions against UBS AG (“UBS”) and Porsche Automobil Holding SE (“Porsche”), federal courts recently dismissed claims (i) based on purchases of securities outside the United States where the non-U.S. issuer had dually listed the class of relevant securities on both U.S. and non-U.S. exchanges, (ii) by U.S. purchasers of a non-U.S. issuer’s securities on a non-U.S. exchange, and (iii) based on securities-based swap agreements referencing shares traded on non-U.S. exchanges. (S&C partners Bob Giuffra and Suhana Han represented both UBS and Porsche.) Following these and other post-Morrison decisions, non-U.S. issuers should take some comfort that they will not expose themselves to “worldwide” securities class actions simply by participating in U.S. capital markets.
“Either the CFTC or the SEC may prohibit an entity from participating in the US swap markets if it is domiciled in a country whose regulation of swaps undermines the stability of the US financial system”.
In July 2010, in response to the financial crisis of 2008/9 which resulted in the deepest economic recession in the United States since the Great Depression of the 1930s, the United States Congress passed, and President Obama signed into law, the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act addresses a broad range of issues including consumer protection, rating agencies, systemic risk, executive compensation, private fund adviser registration, the so-called Volker Rule, and prudential risk regulation. A significant component of the Act is the regulation of derivatives and participants in derivative markets.
In What the changes really mean (IFLR Derivatives Supplement, July 2010), the same authors discussed the provisions of the Act. The main provisions of the legislation relating to derivatives are increased transparency, clearing and exchange trading requirements, regulation of swap dealers and other swap market participants, restrictions on swaps trading by banks and increased capital and margin requirements. It was left to the regulators to promulgate rules and regulations implementing many details of the Act. For almost a year now, the regulators have been proposing many rules and industry participants have been commenting on those proposals. On some issues, the industry is still anxiously awaiting proposed rules in order to obtain clarification of the Act. Due to the incredibly large volume of rules that the regulators were required to adopt and the long process for public comments on proposed rules, although parts of the Act were originally intended to become effective beginning July 16 2011, that date may be extended.