THE CONTINUING IMPACT OF MORRISON
Since the Supreme Court rewrote the rules regarding the extraterritorial reach of Exchange Act Section 10(b) in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869, the circuit and district courts have struggled with its application. In Morrison the High Court created a bright line test, holding that Exchange Act Section 10(b) does not provide a cause of action for securities fraud unless the purchase or sale of securities on which the claim is based either: 1) took place on a U.S. securities exchange or 2) occurred in the United States. Stated differently, the anti-fraud Section of choice in both SEC enforcement actions and private securities fraud cases does not have extraterritorial effect. In reaching its conclusion the Supreme Court rejected decades of case law developed initially by the Second Circuit, and adopted to varying degrees by other circuits, which utilized a jurisdictional test predicated on a conduct and effects standard. The decision is discussed here.
The Second Circuit recently applied the second prong of Morrison in Absolute Activist v. Ficeto, Docket No. 11-0221-cv (2nd Cir. Decided March 1, 2012). The case centered on a claim for damages based on Exchange Act Section 10(b) brought by nine Cayman Island hedge funds managed by Absolute Capital Management Holdings Ltd. (ACM). The defendants were Florian Homm, CIO of ACM, Sean Ewing, Chairman/Chief Executive Officer, Ullrich Angersbach, Head of IR and Marketing and Colin and Craig Heatherington, ACM employees who were principals of defendant CICV Global Capital Ltd. (CIC).
Plaintiffs claimed that over approximately three years Defendants Homm, Ficeto, Hunter and Colin Heatherington caused the nine Funds to purchase U.S. Penny Stocks directly from the issuers in PIPE transactions. Following the purchases various of the defendants are alleged to have engaged in a â€œpump and dumpâ€ type scheme involving the penny stock securities acquired by the Funds. In the end the defendants reaped huge profits while the Funds suffered losses of about $195,916,212.
The district court dismissed the complaint with prejudice. Based on Morrision, that court concluded sua sponte that although no defendant had invoked the decision, under the Supreme Courtâ€™s ruling it lacked subject matter jurisdiction. The Second Circuit reversed and remanded with leave to replead.
Morrison rejected the Second Circuitâ€™s â€œconduct and effects,â€ developed in cases such as SEC v. Berger, 322 F. 3d 187, 192-93 (2nd Cir. 2003) to assess questions regarding the extraterritorial reach of Section 10(b) the Circuit Court noted. Under Morrison the question is whether the securities transaction took place on a U.S. exchange or in this country. This case involves only the second prong of the Morrison test according to the Funds â€“ no claim is made that the first part prong of the decision is applicable despite a ruling in a related SEC enforcement action based on that prong. See, SEC v. Ficeto, No. 11 Civ. 1637, 2011 U.S. Dist. LEXIS 150141, at*31 (C.D.Ca Dec. 20, 2011)(action against defendants Ficeto, Homm, Colin Heatherington and Hunter in which SEC successfully argued that the first prong of Morrision applied since the securities were purchased and sold in the over-the-counter markets).
Morrision did not define the test for determining when the purchases and sale of a security is a domestic transaction. Accordingly, the Circuit Court began its analysis by considering the statutory definitions of purchase and sale. Those definitions include any contract to buy, purchase, or otherwise acquire a security. They thus suggest that the act of purchasing or selling securities is based on entering into a binding contract. Viewed in this context, the key question is when the parties first became bound to effectuate the transaction. To plead a claim under this test the plaintiff must â€œallege facts leading to the plausible inference that the parties incurred irrevocable liability within the United States: that is, that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security,â€ citing SEC v. Goldman Sachs & Co., 790 F. Supp. 2d 147, 159 (S.D.N.Y. 2011).
In reaching its conclusion the Court rejected four alternatives argued by the parties. First, the location of the broker-dealer is not dispositive. While this may be a relevant consideration, it does not demonstrate where the contract was executed. Second, the fact that the securities were issued by U.S. companies and that the shares are registered with the SEC does not necessarily establish that the transactions were domestic within the meaning of Morrision. Likewise, the identity of the buyer or seller is not necessarily determinative of where the transaction took place. Finally, while Morrison did replace the conduct test with a transactional approach as argued by one defendant, the critical question is whether â€œthe parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.â€
In this case the mere allegation that the transactions took place within the U.S. is not sufficient. Rather, plaintiffs must plead â€œfactual allegations suggesting that the Funds became irrevocably bound within the United States or that title was transferred within the United States, including, but not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of money . . . â€œ
Since Morrision was decided after the complaint considered here was filed, plaintiffs will be given an opportunity to replead their complaint.