Publications

On August 30, 2021, the Southern District of New York dismissed with leave to amend an individual action and consolidated purported securities fraud class actions alleging that a Canadian company doing business in the U.S., its senior secured lender, and certain executives at both companies violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by failing to disclose information regarding the company’s relationship with its senior secured lender/largest financer and certain terms of the two entities’ financing. In re iAnthus Cap. Holdings Sec. Litig., 2021 WL 3863372 (S.D.N.Y. 2021) (Kaplan, J.). The court held that the Exchange Act does not apply because its use would be extraterritorial and therefore improper. The court determined that the OTCQX, where the company’s common shares trade in the U.S. over-the-counter market, is not an “exchange” as is required under the first prong of Morrison v. Nat’l Australia Bank, 561 U.S. 247 (2010).

Section 10(b) Does Not Apply Beyond U.S. Borders

The court began its discussion by quoting a recent Second Circuit decision stating that “Section 10(b) of the Securities Exchange Act does not apply beyond U.S. borders.” Quoting Cavello Bay Reinsurance v. Shubin Stein, 986 F.3d 161 (2d Cir. 2021).[1] The court then explained that under Morrison courts must limit the application of Section 10(b) to “transactions in securities listed on domestic exchanges, and domestic transactions[ ] in other securities.”

First Prong of Morrison Applies Section 10(b) to Transactions in Securities Listed on a Domestic Exchange

The court stated that “[u]nder the first prong of Morrison, Section 10(b) is properly applied to transactions in securities listed on domestic exchanges.” Plaintiffs alleged that the company’s common shares trade in the U.S. over-the-counter market on the OTCQX. Therefore, the court framed the issue as whether the OTCQX qualifies as a domestic exchange. The court explained that, according to the SEC’s implementing regulations under the Exchange Act, an exchange “is limited to an organization, association, or group of persons who (1) bring together the orders for securities of multiple buyers and sellers and (2) use established, non-discretionary methods under which such orders interact with each other, and the buyers and sellers entering such orders agree to the terms of a trade.” The court, citing Black’s Law Dictionary, then explained that by contrast “securities traded over-the-counter trade between brokers and dealers who negotiate directly and not on an organized securities exchange or other order-matchmaking service.”

Citing the Third Circuit, the court also stated that “[o]ver-the-counter markets are not national securities exchanges within the scope of Morrison because the stated purpose of the Exchange Act refers to securities exchanges and over-the-counter markets separately, which suggests that one is not inclusive of the other and a national securities exchange is explicitly listed in Section 10(b)—to the exclusion of the OTC markets.” United States v. Georgiou, 777 F.3d 125 (3d Cir. 2015). The court concluded that “over-the-counter transactions in [the company’s] common stock are, by definition, those that do not occur on an exchange within the meaning of Morrison.”

Plaintiffs Failed to Allege Facts Showing the Transactions Qualified as Domestic Transactions Under Morrison’s Second Prong

Separately, the court determined that plaintiffs also failed to allege specific facts showing that any of the three transactions at issue qualified as a “domestic transaction[ ] in other securities” under Morrison's second prong. Transactions are considered domestic under Morrison only “when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.” The court explained that “plaintiffs must allege specific facts including, but not limited to, facts concerning the formation of the contracts, the placement of purchase order, the passing of title, or the exchange of money.” With respect to the transactions at issue, plaintiffs failed to include specific allegations concerning their location and structure. The court noted that “the mere fact that a trade was made through the United States over-the-counter market does not indicate where the parties to that transaction incurred irrevocable liability or where title passed.”