(Article from Securities Law Alert, December 2015)
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Third Circuit: Irrevocable Liability Test Establishes the Location of a Securities Transaction for Purposes of Determining Whether a Transaction is “Domestic” for Morrison Purposes
In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court held that “Section 10(b) applies only to transactions in securities listed on domestic exchanges and domestic transactions in other securities.”
On January 20, 2015, the Third Circuit ruled that “irrevocable liability establishes the location of a securities transaction” for purposes of determining whether a transaction is “domestic” within the meaning of the Morrison decision. United States v. Georgiou, 777 F.3d 125 (3d Cir. 2015) (Greenaway, Jr., J.). Under the “irrevocable liability” test, “‘a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States’” (quoting Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012)). The Third Circuit noted that “[f]acts that demonstrate ‘irrevocable liability’ include the ‘formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money’” (quoting Absolute Activist, 677 F.3d 60).
At issue in the case before the Third Circuit was an alleged “stock fraud scheme” involving stocks traded by foreign entities on two American over-the-counter stock markets, the OTC Bulletin Board and the Pink OTC Markets. The court held that these two over-the-counter stock markets are “not national securities exchanges within the scope of Morrison.”
The court then considered whether the transactions qualified as “domestic transactions” under Morrison’s second prong. Applying the “irrevocable liability” test, the Third Circuit held “as a matter of first impression” that over-the-counter “purchases and sales of securities issued by U.S. companies through U.S. market makers acting as intermediaries for foreign entities constitute ‘domestic transactions’ under Morrison.”
Ninth Circuit: “Personal Benefit” Requirement for Tippee Liability Is Met Where an Insider Discloses Confidential Information to a Trading Relative or Friend, Even If the Insider Received No Potential or Actual Financial Benefit
On July 6, 2015, the Ninth Circuit held that “[p]roof that [an] insider disclosed material nonpublic information with the intent to benefit a trading relative or friend is sufficient to establish the breach of fiduciary duty element of insider trading” for tippee liability purposes. United States v. Salman, 792 F.3d 1087 (9th Cir. 2015) (Rakoff, J.). The Ninth Circuit declined to follow the Second Circuit’s decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014) “[t]o the extent Newman can be read to go so far” as to require that the insider stood to obtain “‘at least a potential gain of a pecuniary or similarly valuable nature’” for disclosing confidential information to a trading relative or friend (quoting Newman, 773 F.3d 438). The Ninth Circuit reasoned that if it were to take this approach, “then a corporate insider or other person in possession of confidential and proprietary information would be free to disclose that information to her relatives, and they would be free to trade on it, provided only that [the insider] asked for no tangible compensation in return.”
The Ninth Circuit also questioned whether Newman in fact requires evidence of such a tangible personal benefit in cases involving disclosures to family members of friends. The court noted that “Newman itself recognized that the ‘personal benefit is broadly defined to include not only pecuniary gain, but also, inter alia, . . . the benefit one would obtain from simply making a gift of confidential information to a trading relative or friend’” (quoting Newman, 773 F.3d 438).
Ninth Circuit: Rule 9(b)’s Particularized Pleading Requirements Apply to Loss Causation Allegations
Rule 9(b) requires that a plaintiff “alleging fraud or mistake . . . state with particularity the circumstances constituting fraud or mistake.” On December 16, 2014, the Ninth Circuit held that “Rule 9(b) applies to all elements of a securities fraud action, including loss causation.” Oregon Public Emps.’ Ret. Fund v. Apollo Group Inc., 774 F.3d 598 (9th Cir. 2014) (Smith, Jr., J.).
The Ninth Circuit determined that applying Rule 9(b) to loss causation allegations “is appropriate for at least three reasons.” First, the court reasoned that “[s]ince Rule 9(b) applies to all circumstances of common-law fraud, . . . and since securities fraud is derived from common law fraud, it makes sense to apply the same pleading standard to all circumstances of securities fraud,” including loss causation. The court noted that “[t]he requirement of loss causation, in particular, is founded on the common law of fraud and deceit.” Second, the Ninth Circuit found that “[l]oss causation is part of the ‘circumstances’ constituting fraud” within the meaning of Rule 9(b) “because, without it, a claim of securities fraud does not exist.” Third, the Ninth Circuit explained that its approach “creates a consistent standard through which to assess pleadings in [Section] 10(b) actions, rather than the piecemeal standard adopted by some courts.”
The Ninth Circuit recognized the existence of a circuit split on whether Rule 9(b) applies to loss causation allegations. The court explained that it was “persuaded by the approach adopted in the Fourth Circuit.” Courts in the Fourth Circuit “review allegations of loss causation for ‘sufficient specificity,’ a standard largely consonant with [Rule] 9(b)’s requirement that averments of fraud be pled with particularity.” Katyle v. Penn. Nat’l Gaming, 637 F.3d 462 (2011).