(Article from Securities Law Alert, February 2021)
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On January 25, 2021, the Second Circuit affirmed the dismissal of a securities fraud lawsuit against a Bermudan holding company operating out of New York and its controller, alleging that defendants had misrepresented the holding company’s fee arrangement before plaintiff, a Bermudan corporation, had purchased shares in the holding company in a private offering. Cavello Bay Reinsurance v. Shubin Stein, 986 F.3d 161 (2d Cir. 2021) (Jacobs, J.). The Second Circuit held that even assuming, without deciding, the transaction was “domestic” under Absolute Activist Value Master Fund v. Ficeto, 677 F.3d 60 (2d Cir. 2012), the claims were so predominantly foreign as to be impermissibly extraterritorial under Parkcentral Global HUB v. Porsche, 763 F.3d 198 (2d Cir. 2014).
Principles Determining the Extraterritorial Reach of Section 10(b)
Plaintiff asserted claims under the Securities Exchange Act, including for rescission under Section 29(b) and for securities fraud under Section 10(b) and Rule 10b-5. Beginning its extraterritorial analysis, the court stated “Section 10(b) of the Securities Exchange Act does not apply beyond U.S. borders. But, in a mostly border-less economy, a plaintiff is allowed some room for a foreign dimension to its claims.” Citing to the Supreme Court’s bright-line rule in Morrison v. National Australia Bank, 561 U.S. 247 (2010), the court stated that “[u]nless a security is listed on a domestic exchange, a domestic transaction is a necessary element of a § 10(b) claim.” However, the court explained “the presence of a domestic transaction alone cannot satisfy the statute’s geographic requirements,” and under Parkcentral, “claims must not be so predominantly foreign as to be impermissibly extraterritorial.”
The court explained that under Morrison, courts are “to use the ‘focus’ of the statute to determine whether a case involves a domestic application of § 10(b).” The court continued that “[t]he focus is upon purchases and sales of securities in the United States, not upon the place where the deception originated.” Id. The court noted that the Supreme Court later clarified in RJR Nabisco v. European Community, 136 S. Ct. 2090 (2016) that “if the conduct relevant to the focus occurred in a foreign country, then the case involves an impermissible extraterritorial application regardless of any other conduct that occurred in U.S. territory.” Citing to Second Circuit precedent, the court stated that, “[p]ut differently, courts must evaluate whether the domestic activity involved implicates the ‘focus’ of the statute.” The court cautioned that “even if a transaction occurs in the United States, the features and incidents of the transaction may nevertheless be so foreign that it is not regulated by § 10(b).” For example, “Parkcentral ruled that the complaint stated an impermissibly extraterritorial claim despite the presence of a domestic transaction.”
Plaintiff Failed to Plead a Domestic Application of Section 10(b)
Applying these principles, the court concluded that plaintiff “has failed to plead a domestic application of § 10(b).” The court explained that “[t]he claims here are based on a private agreement for a private offering between a Bermudan investor [] and a Bermudan issuer [,]” and that plaintiff “purchased restricted shares in [the holding company] in a private offering.” Further, the court continued that “[t]he shares reflect only an interest in [the holding company], and they are listed on no U.S. exchange and are not otherwise traded in the United States.”
The Agreement’s SEC Registration Requirement Not Enough to Trigger Interests That Section 10(b) Is Meant to Protect
The court described the main connection of the shares to the U.S. as “the subscription agreement’s restriction clause requiring [plaintiff] to register the shares with the SEC (or meet an exemption) should [plaintiff] wish to resell them.” The court reasoned that “[w]hile that clause may set up a future invocation of U.S. law, it operates as a mere contractual impediment to resale, conditioning resale on the invocation of U.S. law by a party that has made the purchase in a way that avoids regulation by the United States.” The court pointed out that plaintiff “provides no reason to think an SEC registration requirement—contingent and future—triggers some U.S. interest or other interest that the statute is meant to protect . . . .” The court observed that plaintiff “seeks access to a domestic forum and judicial resources; but the transaction is structured to avoid the bother and expense (and taxation) of U.S. law.” The court concluded that “[t]he transaction implicates only the interests of two foreign companies and Bermuda.”
Alleged Contacts With Territory of the U.S. Did Not Relate to the Purchase and Sale of Securities
The court further deemed that plaintiff’s allegations against the holding company (that it made the misstatement from New York; that the funds were to be invested in U.S. insurance services; that its principal place of business, CEO, and directors were in New York; and that it was managed by a U.S. company) were “not enough.” Instead, the court stated that the contacts with the territory of the U.S. “that matter are those that relate to the purchase and sale of securities.” Addressing the allegations that the parties’ communications executing the agreement were between New York and Bermuda, the court stated that “acts evincing contract formation do not resolve the question whether the claims are nevertheless so predominantly foreign.”