[Authors: John Stigi and Valentina Shenderovich]
In Absolute Activist Value Master Fund Ltd. v. Ficeto, 2012 WL 661771 (2d Cir. Mar. 1, 2012), the United States Court of Appeals for the Second Circuit held that, for purposes of applying the federal securities laws to transactions involving securities not traded on a U.S.-based stock exchange, a transaction is “domestic,” and thus within the reach of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), “if irrevocable liability is incurred or title passes within the United States.” The decision provides important clarification on the standard laid out by the United States Supreme Court in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), which held that Section 10(b) applies only to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.”
In Absolute Activist, plaintiffs were nine Cayman Islands hedge funds (the “Funds”). The Funds sued their investment manager and U.S.-based broker, as well as certain respective principals of these firms, under Section 10(b) for engaging in a “pump-and-dump” scheme. The complaint, filed in the United States District Court for the Southern District of New York, alleged that defendants fraudulently caused the Funds to purchase penny stock from U.S. companies through the U.S.-based broker in “private investment in public equity” transactions, causing the Funds to suffer approximately $196 million in losses.
Defendants moved to dismiss the complaint for failure to state a claim, lack of personal jurisdiction and improper venue. The district court dismissed the complaint in its entirety, ruling that it lacked subject matter jurisdiction over the case under Morrison. In Morrison, the Supreme Court held that Section 10(b) applies only to “transactions in securities listed on domestic exchanges and domestic transactions in other securities,” effectively overruling the “conduct” and “effects” tests previously employed by the Second Circuit. The Supreme Court noted that “[w]ith regard to securities not registered on domestic exchanges, the exclusive focus [is] on domestic purchases and sales.” The Supreme Court, however, did not elaborate on what constitutes a domestic purchase or sale.
The Second Circuit in Absolute Activist reversed the district court’s decision on the issue of subject matter jurisdiction, noting that Morrison held that the question of Section 10(b)’s applicability is one of “merits,” not subject matter jurisdiction. The Court then set out the standards for sufficiently pleading that a transaction is “domestic” where the securities were not traded on a U.S.-based stock exchange — the issue left open in Morrison.
The Second Circuit first considered how the terms “buy,” “purchase,” “sale” and “sell” were defined in the Exchange Act, noting that the definitions suggest that the act of purchasing or selling securities is the act of entering into a binding contract to purchase or sell securities. The Court then analogized to the law regarding determination of the timing of a purchase and sale under the Exchange Act, which looks to the point at which the parties “committed” to one another, or “obligated themselves to perform what they had agreed to perform even if the formal performance of their agreement is to be after a lapse of time.” The Court held that to allege sufficiently that a transaction in securities not listed on a U.S.-based exchange is “domestic,” “a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.”
The Second Circuit rejected other potential tests proposed by the parties. The Court disagreed that the location of the broker-dealer should be used to locate securities transactions because, while a broker’s location may be a relevant factor, it alone did not demonstrate where the contracts were executed. The Court also reasoned that the identity of the issuer is irrelevant, noting that the fact that the securities were issued by U.S. companies and registered with the Securities and Exchange Commission has little bearing under Morrison. Similarly, the Court declined defendants’ proposal to rely upon the identity of the buyer or seller and rejected the contention that it was necessary to determine whether each individual defendant engaged in at least some conduct in the United States, noting that such an inquiry goes to personal jurisdiction, not applicability of Section 10(b).
The Court ultimately held the complaint did not sufficiently allege facts required by Morrison to state a claim under Section 10(b). The Court directed, though, that plaintiffs be granted leave to amend.
In Absolute Activist, the Second Circuit clarified the Supreme Court decision in Morrison by setting forth the circumstances under which transactions in securities not listed on a U.S. exchange may be subject to application of U.S. securities laws: whether irrevocable liability or transfer of title took place within the United States.
For further information, please contact John Stigi at (310) 228-3717 or Valentina Shenderovich at (212) 634-3019.
