Courts have been making slow but steady progress in testing the limits of the 2010 Supreme Court case Morrison v. Nat’l Australian Bank Ltd., 130 S.Ct. 2869 (2010). In Morrison, the Court held the federal securities laws apply only to purchases or sales made “in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Id. at 2888. The Second Circuit has held that the “purchase and sale” of a security occurs when “irrevocable liability” occurs and the parties are bound to the transaction. Absolute Activist Value Master Fund v. Ficeto, 677 F.3d 60 (2d Cir. 2012)

On June 4, 2012, in In re Optimal U.S. Litigation, case number 1:10-cv-04095,Judge Scheindlin of the Southern District of New York threw her hat into the Morrison ring. The case was brought in 2010 by foreign individuals and a foreign investment firm who invested through Optimal Strategic U.S. Equity Fund (“Optimal”). Optimal invested 100 percent of its assets with Bernard Madoff and his firm. Plaintiffs alleged that defendants failed to conduct adequate diligence regarding Madoff, ignored red flags that should have alerted them to Madoff’s fraud, and made misstatements and omissions in connection with the sale of Optimal U.S. shares.

Judge Scheindlin dismissed the Securities Exchange Act claims against the defendants. She noted at the outset that plaintiffs did not even make the argument that irrevocable liability occurred in the United States. She then found that plaintiffs’ purchases of U.S. Optimal shares were not made “in connection with” Madoff’s purported purchases and sales of NYSE-listed stocks. She held that although in other contexts the term “in connection with” has been applied loosely, to do so in the extraterritoriality context would go against Morrison’s presumption against extraterritoriality of federal securities laws. Furthermore, the relationship between Optimal U.S. shares and NYSE-listed stocks was much too attenuated. The strategy disclosed in the offering materials authorized the purchase of a wide range of instruments not listed on a U.S. stock exchange, there was no direct correlation between Optimal U.S. Shares and shares listed on the NYSE, and no actual trades were ever even consummated.

Finally, Judge Scheindlin rejected the plaintiffs’ argument that the “economic reality” of the trade was a domestic purchase. She found that the purchases were not domestic because there was no direct, one-to-one relationship with the U.S. securities, and the securities did not fluctuate in value in direct correlation with the value of the U.S. security. Judge Scheindlin left intact plaintiffs’ claims of common law fraud, negligent misrepresentation and aiding and abetting fraud.

This ruling helps to flesh out the boundaries of the Morrison decision. Judge Scheindlin acknowledged herself the issue “requires further guidance from appellate courts.” Stay posted for further developments in this arena.