Morrison s Transactional Test How Has It Affected Securities Offerings by Non-U.S. Issuers?

Transcription

1 August 2017 Morrison s Transactional Test How Has It Affected Securities Offerings by Non-U.S. Issuers? Seven years after it was issued, the U.S. Supreme Court s decision in Morrison v. National Australia Bank 1 continues to provide non-u.s. companies with a significant defense against claims made under the U.S. federal securities laws. However, the law remains unsettled in many areas and does not provide certainty as to how courts will treat transactions involving non-u.s. issuers under the U.S. federal securities laws. In 2010, the Supreme Court in Morrison reiterated the presumption against the extraterritorial effect of the U.S. federal laws and announced a new transactional test to determine the reach of Section 10(b) of, and Rule 10b-5 under, the Securities Exchange Act of 1934 (the Exchange Act ). 2 The Supreme Court held that Section 10(b) applies only to transactions in securities listed on domestic exchanges and domestic transactions in other securities. 3 Further, in the U.S. Court of Appeals for the Second Circuit, a domestic transaction is necessary but not necessarily sufficient to invoke Section 10(b). In Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings SE, the Second Circuit held that transactions that are so predominantly foreign as to be impermissibly extraterritorial will be dismissed. 4 Recent Developments In re Petrobas Last month, the Second Circuit applied Morrison to the class certification process, vacating a district court s class certification order. In In re Petrobras Securities Contents Recent Developments In re Petrobas... 1 Does Section 10(b) reach transactions in ADRs that are listed on a U.S. exchange?... 3 What if the ADRs are traded on the Pink Sheets or the Over the Counter Bulletin Board?... 4 Is an offering by a non- U.S. issuer made under an exemption from registration (such as Rule 144A) a domestic transaction?... 5 Can a Regulation S offering be deemed a domestic transaction? U.S. 247, 130 S.Ct. 2869, 177 L.Ed.2d 535 (2010). 2 It remains a question whether the transactional test applies to civil enforcement actions brought by the U.S. Securities and Exchange Commission (the SEC ) or the U.S. government, as post- Morrison, the U.S. Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act ) attempted to reinstate the broader conducts and effects test (the predecessor of the transactional test) for such actions. At least one decision, SEC v Traffic Monsoon, LLC, 2017 WL (D. Utah Mar 28, 2017), has held that the older test applies in U.S. government civil enforcement actions, rejecting the argument that Congress intended the Dodd-Frank Act amendment to be mere surplusage. At least two appellate court decisions, however, have held that Morrison s transactional test applies in criminal cases. See U.S. v. Vilar, 729 F.3d 62, 70 (2d Cir. 2013); U.S. v. Georgiou, 777 F.3d 125, (3d Cir. 2015). 3 The plaintiffs in this action purchased their shares in the National Bank of Australia on a foreign exchange. At issue in Morrison was the application of Section 10(b) of the Exchange Act to plaintiffs claims. However, as noted in In re Royal Bank of Scotland Group PLC Sec. Litig., 765 F. Supp. 2d 327, 329 (S.D.N.Y. 2011), the Morrison Court clearly expressed that the territorial reach of the Exchange Act and Securities Act involves the same focus on domestic transactions. See also In re Vivendi, 842 F. Supp. 2d 522, 529 (S.D.N.Y. 2012) F.3d 198, 216 (2d Cir. 2014). 1

2 Litigation, 5 plaintiffs brought claims under both the U.S. Securities Act of 1933 (the Securities Act ) and the Exchange Act against Petróleo Brasileiro S.A. ( Petrobras ) and various other defendants. Petrobas securities American Depositary Shares ( ADS ) listed on the New York Stock Exchange ( NYSE ) and debt securities that were not listed on any U.S. exchange declined significantly in value after the exposure of a multi-billion-dollar money laundering and kickback scheme involving Petrobras. Plaintiffs sought to certify a class under Federal Rule of Civil Procedure 23, which, among other things, requires that class members be defined using objective criteria that establish a membership with definite boundaries (the ascertainability requirement), and that common questions predominate over any questions affecting only individual class members (the predominance requirement). The district court certified one class asserting Securities Act claims and another class asserting Exchange Act claims. The Second Circuit affirmed the lower court s finding that each class was sufficiently ascertainable and that plaintiffs were entitled to a presumption of reliance under the fraud on the market theory, but vacated the finding that the predominance requirement was satisfied with respect to the securities that were not listed on a U.S. exchange. Under Morrison, the plaintiffs would have to show that such securities were acquired in a domestic transaction to assert claims under the federal securities laws. As set out by the Second Circuit in Absolute Activist Value Master Fund Ltd. v. Ficeto, 6 a transaction will be deemed domestic if either (1) the purchaser incurred irrevocable liability within the United States to take and pay for the security, or the seller incurred irrevocable liability within the United States to deliver the security; or (2) title to the security transferred in the United States. Absolute Activist holds that the focus in determining the occurrence of irrevocable liability is the location of the securities transactions at issue in the case and that particular emphasis would be placed on the securities contract itself, its terms and the activities surrounding it. 7 As examples of the types of allegations that might satisfy its test for what qualifies as a domestic transaction, the Second Circuit cited facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money. 8 In In re Petrobas, the court held that, on the available record, the investigation of domesticity appeared to be an individual question requiring putative class members to present evidence that varies from member to member. The sort of transaction-specific facts discussed in Absolute Activist were not clearly susceptible to class-wide proof, and plaintiffs did not suggest a form of representative proof that would answer the question of domesticity for individual class members. The court noted that the potential for variation across putative F.3d 250 (2d Cir. 2017) F.3d 60, 67 (2d Cir. 2012). 7 Id. at Id. 2

3 class members who sold them the relevant securities, how those transactions were effectuated, and what forms of documentation might be offered in support of domesticity appeared to generate a set of individualized inquiries that must be considered within the framework of Rule 23(b)(3) s predominance requirement. Consequently, the court vacated the certification of the classes insofar as they included all otherwise eligible class members who acquired their securities in domestic transactions, and remanded the case back to the district court to determine whether proof of domestic purchase represented a common question that could be answered with respect to members of the class as a whole through generalized proof. In re Petrobas illustrates that the Morrison test is not as clear as it first seemed in 2010, when it replaced 40 years of conducts and effects jurisprudence. While Morrison has certainly resulted in the dismissal of a number of claims, the case law has not provided clear guidance regarding how transactions should be structured in practice to minimize liability under the U.S. federal securities laws. Below are a few of the most common areas of inquiry for non-u.s. companies considering whether to offer securities to U.S. investors: Does Section 10(b) reach transactions in ADRs that are listed on a U.S. exchange? American Depositary Receipts ( ADRs ) 9 represent an interest in the securities of a non-u.s. company that have been deposited with a U.S. bank and often are listed on U.S. exchanges. An ADR holder can generally exchange his or her ADR for the underlying shares at any time. According to the latest line of court decisions, to the extent ADRs are U.S.-listed, sales of such securities would likely be deemed transactions in securities listed on domestic exchanges and thus be subject to the Exchange Act and the Securities Act. 10 However, at least one early S.D.N.Y. case suggested that the Securities Act and the Exchange Act do not apply to ADRs, even if U.S.-listed, as they are foreign securities Although they are different, the term ADR is typically used interchangeably with the term ADS. 10 Defendants often do not challenge this principle. See, e.g., In re Petrobas, 862 F.3d at 262 fn. 12 ( all parties appear to have proceeded under the assumption that Morrison applies to ADSs in the same manner that it applies to common stock ); In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512, 525 (S.D.N.Y. 2011) ( The parties agree that Morrison has no impact on the claims of ADR purchasers since Vivendi's ADRs were listed and traded on the NYSE. ). 11 In In re Societe Generale Sec. Litig., 2010 U.S. Dist. LEXIS (S.D.N.Y. 2010), one group of plaintiffs purchased the shares of Société Générale traded on the Euronext Paris and another purchased ADRs traded over the counter in New York. While the defendants only moved to dismiss the claims of the plaintiffs holding foreign exchange-traded shares, the court found that Morrison compels the dismissal of all claims against the defendants. The court held that purchasers of ADRs (which were purchased over the counter and not listed on a U.S. exchange) are precluded from asserting claims under the Exchange Act. The court said: because [t]rade in ADRs is considered predominantly a foreign securities transaction, Section 10(b) is inapplicable. An ADR represents one or more shares of a foreign stock or a fraction of a share (internal quotation marks omitted). In a footnote, however, the court cited Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620 (S.D.N.Y. 2010) as a decision where a court held that Morrison precludes claims even by purchasers of ADRs listed on an exchange. However, in Cornwell, the court was only asked to consider, and only dismissed, claims by investors who purchased on the Swiss Stock Exchange, and not the claims of purchasers of ADRs listed on the NYSE. 3

4 As in Morrison, the courts have been fairly consistent in finding that an ADR listing in the United States does not mean that Section 10(b) reaches transactions in the company s shares not listed on a U.S. exchange, even though such securities are identical to the securities underlying the ADRs. 12 In such cases, the courts typically dismiss the claims relating to the securities that are only listed only on non-u.s. exchanges and allow the claims based on ADRs listed on a U.S. exchange (usually a much smaller proportion of the purported class) to proceed. What if the ADRs are traded on the Pink Sheets or the Over the Counter Bulletin Board? Several courts have indicated that ADRs traded only in the over the counter ( OTC ) markets such as on the Pink Sheets or OTC Bulletin Board would not satisfy Morrison s first prong, as such markets are not domestic exchanges. (i.e., one of the registered national security exchanges, such as the NYSE). 13 In at least one case, however, in the context of an SEC enforcement action targeting market manipulation of the domestic OTC securities market, the court held that the distinction in Morrison was between domestic versus foreign exchanges, and not domestic exchanges versus the domestic OTC market. 14 The court acknowledged, however, that the analysis could be different for a privately negotiated purchase between individually contracting parties. It is also possible that transactions in OTC securities could satisfy Morrison s second prong and be deemed a domestic transaction. Where a non-u.s. company has sponsored an ADR program, has direct involvement in the domestic ADR offering, and the associated broker-dealers, settling agents, and clearing houses are U.S. institutions, the company could be deemed to have taken affirmative steps to makes its securities available to U.S. investors and thus fall within the reach of Section 10(b). 15 If, however, the ADR program is unsponsored i.e., the ADRs are issued by a depositary bank for already outstanding foreign shares without the agreement or involvement of the issuer it is more difficult to argue that the issuer has taken affirmative steps to make its securities available to U.S. investors See Liu Meng-Lin v. Siemens AG, 763 F.3d 175 (2d Cir. 2014); City of Pontiac Policemen s and Firemen s Retirement Sys. v. UBS AG, 752 F.3d 173 (2d Cir. 2014); and In re Royal Bank of Scotland Grp. PLC Sec. Litig., 765 F. Supp. 2d 327, 336 (S.D.N.Y. 2011); Infineon Techs. AG Secs. Litig., 2011 U.S. Dist. LEXIS (N.D. Cal. 2011); In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512 (S.D.N.Y. 2011); In re Alstom SA Securities Litigation, 741 F. Supp. 2d 469 (S.D.N.Y. 2010). 13 See United States v. Georgiou, 777 F.3d 125 (3d Cir. 2014); In re Volkswagen Clean Diesel Mktg., Sales Practices, & Prods. Liab. Litig., 2017 U.S. Dist. LEXIS 1109 (N.D. Ca. 2017); Stoyas v. Toshiba Corp., 191 F. Supp. 3d 1080 (C.D. Ca. 2016); and In re Societe Generale Sec. Litig., 2010 U.S. Dist. LEXIS (S.D.N.Y. 2010). 14 SEC v. Ficeto, 839 F. Supp. 2d 1101 (C.D. Cal. 2011). 15 See In re Volkswagen, 2017 U.S. Dist. LEXIS at *815; Vancouver Alumni Asset Holdings Inc. v. Daimler AG, 2017 U.S. Dist. LEXIS (C.D. Cal. 2017) 16 See, e.g., Stoyas v. Toshiba Corp., 191 F. Supp. 3d 1080 (C.D. Ca. 2016). 4

5 Is an offering by a non-u.s. issuer made under an exemption from registration (such as Rule 144A) a domestic transaction? Very few cases have addressed whether an offering made by a non-u.s. issuer pursuant to an exemption from registration under the Securities Act such as Rule 144A or Regulation D is a domestic transaction. Typically, in such an offering, the non-u.s. issuer is offering securities outside the United States that are listed in its home jurisdiction and privately (i.e., not listed) in the United States to qualified institutional buyers ( QIBs ) or accredited investors. Consequently, in order for Section 10(b) or Rule 10b-5 to apply, the transactions must satisfy Morrison s second prong that is, they must be domestic. In one of the few cases to address the issue, the D.C. District court held that Section 10(b) applied to transactions in the Restricted Depository Shares ( RDSs ) of Carlyle Capital Corporation ( CCC ), which were offered to U.S. investors pursuant to Regulation D and Rule 144A. 17 The court said that there was no question that the RDSs were bought and sold in the United States, listing the following allegations as support for the conclusion that the RDSs were purchased in the United States for Morrison purposes: > The RDSs were sold to U.S. investors under Regulation D and Rule 144A, registration exemptions applicable to securities sold in the United States; > The RDSs were issued by The Bank of New York, which described them as U.S. securities on their website; > The subscription documents were transmitted to Citigroup Global Markets, Inc., a U.S. broker-dealer in New York; > CCC hired six New York-based broker-dealers for solicitation of purchasers throughout the United States; > U.S. investors were only permitted to purchase RDSs in the offering because they were not eligible to buy Class B shares; and > Plaintiffs were residents of the United States and their participation in the offering was solicited by their stockbrokers, who were registered U.S. broker-dealers. There are other decisions that involve securities sold in private offerings, but they do not discuss whether a registration-exempt offering can categorically be deemed a domestic transaction and perhaps that is to be expected, as such offerings can significantly vary in structure. As discussed above, while Morrison provides little guidance on what constitutes a domestic transaction, the Second Circuit addressed the issue in Absolute Activist, where it noted that a plaintiff must allege facts demonstrating that (1) either 17 Phelps v. Stomber, 883 F. Supp. 2d 188, 206 (D.D.C. Aug. 13, 2012). 5

6 irrevocable liability was incurred within the United States or (2) title was transferred within the United States. The cases that have addressed the domestic transaction prong have come to a range of conclusions: > A purchaser s citizenship or residency does not affect where a securities transaction occurs, as a foreign resident can make a purchase within the United States, and a U.S. resident can make a purchase outside the United States; 18 and > The following are not sufficient facts on their own to make a transaction domestic : - The wire transfer of funds to a bank account in New York; 19 - Defendant s marketing efforts in the United States (including preparation of marketing materials and communicating with investors from the New York office); 20 - Clearing and settlement of the securities in the United States, such as through the National Securities Clearing Corporation or the Depository Trust and Clearing Corp; 21 - The location of the brokers in the United States; 22 - The entry of a buy order from the United States that is executed abroad; 23 and - The transfer of money to a U.S. bank for the purchase of securities where the payment was one step that did not complete the transaction, as the seller could reject the transaction. 24 However, where the delivery of funds to a U.S. bank automatically 18 Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 67 (2d Cir. 2012). The Second Circuit in Absolute Activist highlighted some factors that it considers irrelevant for determination of irrevocable liability, including the nationality of the plaintiffs and their investors, defendants marketing efforts in the U.S., defendants nationality, and the location of the banks that processed investors payments. 19 Loginovskaya v. Batratchenko, 764 F.3d 266, (2d Cir. 2014). 20 S.E.C. v. Goldman Sachs & Co., 790 F.Supp.2d 147, 157 (S.D.N.Y. 2011); Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 798 F.Supp.2d 533 (S.D.N.Y. 2011). In Basis Yield, the activities that allegedly have taken place in the United States included preparation of promotional materials and cash flow projections, a conference call preceding the sale, in which the defendant allegedly provided the plaintiff with false information and allegedly induced the plaintiff to purchase the securities; as well as the transfer of the purchase price for the securities to defendant s account in New York. However, in Stackhouse v. Toyota, 2010 U.S. Dist. LEXIS 79837, at *1 (C.D. Cal. 2010), the court stated that purchases and sales of securities explicitly solicited by the issuer within the United States could be considered domestic transactions, with no discussion of what explicitly solicited means. 21 In re Petrobras Sec. Litig., 150 F. Supp. 3d 337, (S.D.N.Y. 2015); In re Sanofi-Aventis Sec. Litig., No , 2013 WL (S.D.N.Y., 2013). 22 Id. 23 City of Pontiac Policemen s & Firemen s Ret. Sys. v. UBS AG, 752 F.3d 173, 181 (2d Cir. 2014); Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 753 F. Supp. 2d 166 (S.D.N.Y. Oct. 4, 2010). 24 Cascade Fund, LLLP v. Absolute Capital Mgmt. Holdings Ltd., 2011 U.S. Dist. LEXIS 34748, (D. Colo. Mar. 31, 2011). 6

7 consummates the transaction, irrevocable liability has been incurred in the United States. 25 Further, the existence of conditions precedent to the closing of a deal do not render the transaction non-domestic. 26 The cases do not add up to a clear picture of how a non-u.s. issuer could structure a private offering so as to avoid Section 10(b) liability, or indeed, whether doing so is possible. Can a Regulation S offering be deemed a domestic transaction? It seems incongruous that an offering made pursuant to Regulation S an exemption from registration for offshore offerings could be deemed a domestic transaction under Morrison. However, in Arco Capital Corp. v. Deutsche Bank AG, the S.D.N.Y. court refused to dismiss Section 10(b) claims made in connection with securities (the Earls Eight Notes ) offered in accordance with Regulation S. 27 The court found that Arco had incurred irrevocable liability within the United States per the reasoning set out in Absolute Activist, relying on the following factual allegations: Arco s purchase of Earls Eight Notes from Deutsche Bank was effectuated by means of the execution of documents by Arco Capital Management LLC, a Puerto Rico LLC as attorney in fact for Arco, from its offices in Puerto Rico. Deutsche Bank s counsel, located in New York, held the signature pages for both Arco and Deutsche Bank. When the transaction was agreed, Deutsche Bank's counsel ed the signature pages to Arco in Puerto Rico and Deutsche Bank in London, copying... personnel in New York. The Earls Eight Notes were sold into Arco's prime brokerage account at Citigroup, located in New York, NY. On July 17, 2008, Arco Capital Management LLC from its offices in Puerto Rico transmitted to the London Branch of Deutsche Bank a cross-receipt evidencing closing of the transaction. The court rejected Deutsche Bank s argument that Morrison precludes the application of Section 10(b) and Rule 10b-5 to offshore transactions, pointing to the Preliminary Notes to Regulation S, which specifically state that the regulation does not provide a safe harbor from the antifraud provisions of the federal securities laws. However, in Parkcentral Global, which followed Arco in 2014, the Second Circuit provided an additional threshold to Morrison s second prong, stating that a transaction must not be so predominantly foreign as to be impermissibly extraterritorial in order for Section 10(b) to apply. The court found that plaintiffs 25 Arco Capital Corp. Ltd., v. Deutsche Bank, AG, 949 F. Supp. 2d 532, 543 (S.D. N.Y., 2013). 26 See, e.g., Arco Capital Corp., 949 F. Supp. 2d at (S.D.N.Y. 2013); Liberty Media Corp. v. Vivendi Universal, S.A., 861 F. Supp. 2d 262, 269 (S.D.N.Y. 2012) F. Supp. 2d at

8 had failed to invoke Section 10(b) and Rule 10b-5 in a manner consistent with the presumption against extraterritoriality, as their allegations concerned statements made by defendants primarily in Germany with respect to stocks in a German company traded only on a non-u.s. exchange. There have not yet been any cases applying Parkcentral Global to Regulation S transactions, but the ruling should make it even more difficult for plaintiffs to succeed with such claims, particularly where the purchase/sale and delivery of the securities is outside the United States. * * * * * We will continue to monitor developments in this area and welcome any queries you may have. If you have any questions, please contact the people on the right or your usual Linklaters contacts. Contacts For further information please contact: Jeffrey Cohen jeffrey.cohen@linklaters.com Doug Davison doug.davison@linklaters.com Caird Forbes-Cockell caird.forbes-cockell@linklaters.com Adam Lurie adam.lurie@linklaters.com Luis Roth This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2017 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC It is a law firm authorised and regulated by the Solicitors Regulation Authority. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the nonmembers who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on Please refer to for important information on Linklaters LLP s regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. luis.roth@linklaters.com Pam Shores pam.shores@linklaters.com Daria S. Latysheva Associate daria.latysheva@linklaters.com Linklaters.com 8