This can be a crucial question. U.S. Securities laws are manageable with guidance from an experienced U. S. Securities lawyer, but if you are involved in a transaction and do not realize it is subject to the U. S. Securities laws, you are headed for big trouble.
Recent Cases Provide Insight Into Applicability of United States Securities Laws to International Transactions
In recent years, the question of when the United States’ securities laws may apply to international transactions has been a prominent topic for various United States courts. Until a few years ago, questions of whether United States Securities laws apply to international transactions were primarily determined by two tests:
(1) the “effects test,” which asked whether any wrongful conduct, like fraud, had a substantial effect in the United States or upon United States citizens; and
(2) the “conduct test,” which asked whether the wrongful conduct had taken place in the United States.
In 2010, however, the Supreme Court of the United States propounded entirely new methodology for determining whether United States Securities laws are applicable to international transactions in Morrison v. National Australia Bank Ltd.[i]
In Morrison, three Australian plaintiffs sued National Australia Bank, an Australian bank (“National”), and HomeSide Lending, Inc., a Florida mortgage servicing company whose parent company was National (“Homeside”). The plaintiffs, who all held National shares, alleged that National and HomeSide had violated the Exchange Act by allegedly manipulating HomeSide’s financial models to make it appear that instances of early repayment significantly lower than they actually were, so HomeSide’s mortgaging servicing rights would seem more valuable.
The United States Supreme Court held that the U. S. Securities law did not apply to National’s alleged fraud because the facts of the case did not satisfy a new “transactional test.” The transactional test provides that the U. S. Securities laws only apply to international transactions if the transaction either involves domestic securities or is a domestic transaction in other securities. Morrison, however, did not elaborate on what a “domestic transaction” is. In recent years, various U. S. Courts of Appeals (the intermediate appellate Courts in the U.S. judicial system) have clarified the answer to that question.
In 2012, Absolute Activist Value Master Fund Ltd v. Ficeto[ii],elaborated on what a domestic transaction is. In this case, some Cayman Islands hedge funds that bought shares of companies not traded on a U.S. exchange sued officers of an investment management company that the funds retained and principals of a United States broker-dealer alleging violations of the U.S. Securities laws. The Court of Appeals for the Second Circuit[iii] held that a transaction is domestic when irrevocable contractual liability is incurred in the United States or title to the securities passes in the United States.
Absolute Activist was not the only case to consider when a domestic transaction takes place. In an earlier case from 2011, Quail Cruises v. Agencia de Viagens CVC Tur Limitada[iv], a Bahamian cruise ship operator that purchased the famous Love Boat through a purchase of stock of another Bahamian corporation, sued the vessel’s previous owner, a Brazilian corporation, alleging fraud under the U. S. Securities Laws. The Court of Appeals for the Eleventh Circuit held that the U. S. securities laws could be applied to the stock purchase because the transaction for the acquisition of the Bahamian stock had taken place in Miami, Florida.
In 2013, the District Court (a trial level Court) for the Northern District of Illinois (Chicago) considered the question of what a domestic transaction is in SEC[v] v. Benger[vi]. In that case, a group of Illinois citizens handled purchases of foreign stock for foreign purchasers. The SEC allegedly found evidence that the Illinois citizens had engaged in a boiler room scheme and charged them with violations of the U. S. securities laws. The court held that while the Illinois citizens may have overseen the sale of the stock, title did not pass in the United States, resulting in the SEC not having subject matter jurisdiction.
The decisions in Quail Cruises and Benger raised a question of whether a domestic transaction can ever take place when title does not appear to explicitly pass in the United States. In United States v. Ahmed[vii], the District Court for the District of Connecticut considered whether the U. S. Investment Advisers Act’s antifraud provisions could be applied to a case where the underlying contracts provided that title to the relevant securities would pass outside the United States. The Court, however, found that in practice, title passed in the United States. For example, evidence showed that a number of transfer instruments were electronically sent to one of the defendants’ registered email addresses.
In another case, United States v. Georgiou[viii], the Court of Appeals for the Third Circuit provided guidance into the meaning of the “irrevocable liability” standard established in Absolute Activist. The Third Circuit held that facts that typically result in irrevocable liability include “formation of the contracts, the placement of purchase orders, the passage of title, or the exchange of money.” Facts such as heavy marketing in the United States or a party’s citizenship, however, are not sufficient to warrant irrevocable liability. The Third Circuit found that a domestic transaction had taken place because at least one of the transactions in question had taken place through United States-based market makers, thereby creating irrevocable liability.
Two recent cases have reached somewhat different conclusions in considering how the “domestic transaction” test works when derivatives of foreign securities are involved. The Ninth Circuit Court of Appeals (California) recently considered the question in Stoyas v. Toshiba[ix]. The plaintiffs in this case, who were purchasers of American Depository Shares, or ADRs, sued Toshiba under the U. S. Securities laws alleging accounting fraud. Toshiba argued that the U. S. Securities laws could not be applied extraterritorially, noting that ADRs’ primary function is to enable American investors to purchase stock traded on foreign exchanges and that the ADRs were transferred on alternative trading systems, not U. S. Securities Exchanges. The Ninth Circuit held that although the underlying Toshiba shares were traded on foreign exchanges, the ADRs were themselves securities and title to them had passed in the United States on an alternative trading system.
In Park Central Global Hub Ltd. v. Porsche Auto Holdings SE[x], the Second Circuit reached a different conclusion as to whether the U.S. Securities laws applied to swap transactions relating to Volkswagen stock which took place in New York City. The plaintiffs, in this case, alleged that Porsche had made misleading statements regarding its intent to acquire Volkswagen, thus causing the price of Volkswagen stock to artificially increase. The Second Circuit concluded that the U. S. Securities laws did not apply, noting that even though the swap transactions took place in the United States, that alone was not sufficient to warrant application of the U. S. securities laws. Evidence showed that the alleged misleading statements had taken place outside the United States and that title to the Volkswagen stock was to pass in Europe.
The above cases show that there is no simple, bright line answer as to when United States Securities laws apply to transactions involving foreign securities. It is an issue that United States courts will likely continue to address as the world becomes more integrated.
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[i]Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010).
[ii] Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2nd Cir. 2012).
[iii] The Second Circuit Court of Appeals covers Wall Street and thus is a particularly influential court concerning the U. S. Securities laws.
[iv] Quail Cruises Ship Mgmt Ltd. v. Agencia de Viagens CVC Tur Limitada, 645 F.3d 1307 (11th Cir. 2011).
[v]SEC is a common abbreviation for the United States Securities and Exchange Commission which is the U. S. Governmental agency charged with enforcing the U. S. securities laws on behalf of the government. The U. S. securities laws can be enforced by private lawsuit, by administrative and court actions by the SEC and criminally by United States Attorneys.
[vi] SEC v. Benger, 2013 WL 593952 (N.D. Ill. Feb. 15, 2013).
[vii] United States v. Ahmed, 308 F. Supp. 3d 628 (D. Conn. 2018).
[viii] United States v. Georgiou, 777 F.3d 125 (3rd Cir. 2015).
[ix] Stoyas v. Toshiba Corp., 896 F.3d 933 (9th Cir. 2018).
[x] Parkcentral Global Hub Ltd. v. Porsche Auto Holdings SE, 763 F.3d 198 (2nd Cir. 2014).