Vedder Thinking | Articles Second Circuit Interprets Morrison: Domestic Transactions in Securities on a Foreign Exchange
Absolute Activist Value Master Fund Ltd. v. Ficeto, Case No. 11-0221-cv
(2d Cir. Mar. 1, 2012)
On March 1, 2012, the Second Circuit issued a ruling concerning the second prong of the U.S. Supreme Court’s decision in Morrison v. Nat’l Australia Bank Ltd., in which the Court held that U.S. securities laws apply only to (1) transactions in securities listed on domestic exchanges and (2) domestic transactions in other securities. Answering the question of when a transaction involving securities not listed on a U.S. exchange can still be a “domestic” transaction, the Second Circuit concluded that, in order to establish a domestic transaction in other securities, a plaintiff “must allege facts suggesting that either irrevocable liability was incurred or title transferred within the United States.”
The plaintiffs in Absolute Activist include nine Cayman Islands hedge funds that invested in various asset classes on behalf of hundreds of U.S. and other investors worldwide. The complaint alleges that various officers and employees of the funds’ investment manager, Absolute Capital Management Holdings Limited, engaged in a “pump-and-dump” scheme, causing the funds to purchase billions of shares of thinly capitalized U.S.-based companies, falsely inflating the value of those companies and then unloading their personal holdings in the companies at a significant profit. While the defendants reaped enormous profits, the hedge funds allegedly suffered losses in the amount of $195,916,216.
The issue before the Second Circuit was whether the securities the Cayman Islands hedge funds had purchased satisfied Morrison’s second prong, thus addressing “under what circumstances the purchase or sale of a security that is not listed on a domestic exchange should be considered ‘domestic’ within the meaning of Morrison.” The Second Circuit noted that Morrison provided very little guidance on what constitutes a domestic purchase or sale, but it examined the definition of those terms in the securities laws and under prior decisions concerning the timing of purchases and sales of securities. The court translated the standard for determining such timing—which is the point in time at which the parties become irrevocably bound—into the standard to be applied when determining the locus of a securities purchase or sale. Thus, a plaintiff has alleged the existence of a domestic transaction if there are sufficient facts to create an inference 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.”
Noting that the irrevocable-liability test is not the only way to identify a securities transaction, the Second Circuit also added the location at which title to the shares at issue was transferred.
In issuing its ruling, the Second Circuit expressly rejected certain tests for determining the domesticity of a securities transaction that the parties had proposed, including (1) the location of the broker-dealer, (2) the identity of the securities and whether they are issued by US companies, (3) the respective identity of the buyer and seller and (4) the level of conduct that took place in the United States by the alleged wrongdoer.
As written, the Absolute Activist complaint failed to adequately allege that the parties had incurred irrevocable liability to carry out the transaction within the United States or that title to the shares had passed within the United States. Despite the fact that the offerings were direct sales by U.S. companies to the hedge funds and the stocks were SEC-registered, the complaint asserted only a few allegations that even hinted at the location of the securities transactions at issue. Thus, the Second Circuit remanded the case to the district court, granting plaintiffs leave to amend their complaint in order to plead additional facts to support their claim that the transactions took place in the United States.
While the Second Circuit’s ruling appears at first blush to take a fairly narrow approach to what transactions may be considered domestic, Absolute Activist could potentially expand the number of cases that may be brought in the United States under U.S. securities laws. Despite the Second Circuit’s express restrictions on the domesticity of transactions on non-U.S. exchanges by specifically enumerating certain allegations that would not suffice, the court, in remanding the case, provided much guidance on the types of factual allegations that should be asserted to allow plaintiffs to survive a motion to dismiss. Armed with the express guidance to allege facts concerning where money was exchanged, where contracts were formed, where purchase orders were executed and where title passed, more plaintiffs may opt to prosecute their cases under the second prong of Morrison and thereby be able to sufficiently allege facts allowing their cases to survive dismissal.
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