The Second Circuit’s “Foreign-Cubed” Decision Applied

In The City of Edinburgh Council v. Vodafone, Case No. 07-Civ. 9921 (S.D.N.Y), the court dismissed a securities fraud action for lack of subject matter jurisdiction. In its ruling, the court followed and applied the teachings of the Second Circuit’s first “foreign-cubed” decision, Morrison v. National Australia Bank, Ltd., 2008 WL 4660742 (2nd Cir. Oct. 23, 2008), discussed here.

City of Edinburgh was brought against telecommunications giant Vodafone and four members of its management and board. The amended complaint claimed that the company, which is registered for trading on European exchanges, has ADR’s listed in New York and files reports with the SEC, issued financial statements that falsely inflated the results and future business prospects of the company. This occurred to cover up the fact that it failed to timely account for certain write-downs from a failed acquisition. The misstatements focused primarily on the operations of the company abroad. Two presentations about the company were made to investors in New York.

The court granted defendants’ motion to dismiss for lack of jurisdiction after plaintiff declined an invitation to supplement its papers. Generally, in resolving a subject matter jurisdictional challenge, a two-part test may be considered. First is the conduct test. That test looks to whether the wrongful conduct occurred in the United States. Here, the question is whether substantial acts in furtherance of the fraud happened in the U.S.

Second is the effects test. This test focuses on whether the conduct had substantial effects in the U.S. or on its citizens.

Here, like Morrison, plaintiffs based their claim of jurisdiction solely on the conduct test, not the effects test. The complaints, as well as supplemental materials submitted by plaintiffs, were notable for their lack of factual detail. While the complaint alleged generally that jurisdiction is proper in the U.S., it failed to state that the fraudulent conduct occurred in the U.S. In fact, the complaint did not allege any situs of the fraud or specify where any of the misstatements were made. The complaint also failed to identify the nationality of the officers or even of the plaintiff.

In view of the lack of specific factual allegations tying the claimed fraud to the U.S., the court concluded that here “it appears that a United Kingdom company, overseen by executives and directors operating abroad, with common shares traded in London and Frankfurt exchanges, devised and implemented a scheme to artificially inflate the Company’s share price, allegedly to the damage of a United Kingdom plaintiffs. Vodafone’s conduct in the United States was incidental, and was limited to a pair of presentations by defendant Arun Sarin in New York … .”

While misleading financial statements prepared abroad and filed here with the SEC may support subject mater jurisdiction, it failed to do so in this case according to the court. As in Morrison, plaintiff here did not rely on the effects test. In relying exclusively on the conduct test to support jurisdiction, the question is “the location of the underlying acts of fraud and their nexus to the United States. Based on the record before [the court], it appears that any activity in the U.S. was secondary, and that, as with Morrison … the responsibility for ensuring the accuracy of public statements lies abroad.” Accordingly, the court concluded that defendants’ conduct in the U.S. was merely preparatory to any claimed acts of securities fraud. Those acts were not sufficient to establish jurisdiction.

Thanks to Lawyer Links which sent me this and other decisions commented on in this space.

Former Broker Pleads Guilty To Obstructing SEC Insider Trading Investigation

George L. Smith pled guilty yesterday to one count of obstructing an SEC insider trading investigation. Mr. Smith is a former director and founding member of the Chicago Board of Options Exchange, director of the American Stock Exchange, chairman and founding member of the AMEX Commodities Exchange and managing director of New York City broker dealer Broadband Capital Management LLC.

Mr. Smith’s plea is based on allegations that during an SEC investigation into whether he engaged in insider trading, he submitted false documents, gave false testimony and procured false testimony by his administrative assistant. Specifically, the information alleged that in December 2003 Mr. Smith submitted documents to the SEC in response to a subpoena which included a memorandum that appeared to support his claim that he traded in the shares of a Pharmaceutical Company based on personal research rather than inside information. The memo, dated prior to his trades, recommended that account executives at Broadband consider as “good candidates to watch” a series of companies, including the one in which he traded. Attached was a Forbes Magazine article about the Pharmaceutical Company. In July 2004 Mr. Smith testified before the SEC that he circulated the memo prior to his trades and that it constituted the basis for his trades.

After the SEC expanded its insider trading investigation, Mr. Smith submitted a similar memo to the SEC regarding an Implant Company. In April 2006, a memo with attachments which Mr. Smith claimed demonstrated he traded in the Implant Company based on his independent research was furnished to the SEC. This memo, like the one about the Pharmaceutical Company, was dated prior to his trades. Attached were two analyst reports recommending the Implant Company. The memo was purportedly distributed at Broadband. Later Mr. Smith asked his administrative assistant to confirm that she had discovered the memo while reviewing the files.

In fact, both memos, according to the information, were fabricated. Likewise, Mr. Smith’s administrative assistant did not discover the second memo while searching the files. Mr. Smith is due to be sentenced in March 2009.