How Far Does Section 10(b) Reach? The Second Circuit Says That A Domestic Transaction Is Necessary, But Not Sufficient, To Invoke U.S. Securities Laws

In a long-awaited opinion issued on August 15 in Parkcentral v. Porsche, the Second Circuit limited the extraterritorial reach of the U.S. securities laws, affirming the dismissal of securities claims brought by parties to swap agreements that were entered into in the United States but were based on the price of foreign securities.  Although the Parkcentral opinion offers an important interpretation of the Supreme Court’s 2010 opinion in Morrison v. National Australia Bank, the Second Circuit declined to set forth a bright-line rule for determining when a securities fraud claim based on domestic transactions in foreign securities is sufficiently “domestic” to be subject to U.S. securities laws, thereby leaving the door open to future litigants to confront this issue in securities cases involving foreign elements.

In Morrison, the Supreme Court found that Section 10(b) of the Exchange Act does not apply extraterritorially based on a lack of congressional intent to overcome the strong presumption against the extraterritorial application of domestic laws.  In so holding, the Court rejected a long line of Second Circuit cases that allowed the application of Section 10(b) to claims involving foreign securities so long as the claims involved either significant conduct in the U.S. or some effect on U.S. markets or investors.  The Supreme Court reasoned that the Second Circuit’s so-called “conduct test” and “effects test” improperly extended the geographic reach of the U.S. securities laws beyond Congress’s intent, and would interfere with foreign countries’ own securities regulations.  Instead, the Court adopted a new “clear test,” holding that Section 10(b) applies only to claims based on: (1) “transactions in securities listed on domestic exchanges” or (2) “domestic transactions in other securities.”

In Parkcentral, the Second Circuit considered claims which, on their face, appeared to satisfy the second prong of the Morrison test.  Plaintiffs were international hedge funds that entered into swap agreements pegged to the price of Volkswagen shares, which are not traded on domestic exchanges.  Plaintiffs claimed that Porsche, also a German corporation, and its executives made fraudulent statements about Porsche’s intentions to acquire VW stock, resulting in a dramatic rise in the VW stock price that caused Plaintiffs (who essentially held a short position in VW stock) to lose money.  Porsche was not a party to any of the securities-based swap agreements entered into by Plaintiffs, and Porsche’s alleged misconduct took place primarily in Germany.  Plaintiffs argued that because they entered into their VW swap agreements in the U.S., their claims were based on “domestic transactions in other securities” and therefore subject to U.S. securities laws because they satisfied the second prong of the Morrison test.

The Second Circuit declined to adopt Plaintiffs’ argument, and instead held that the Morrison test only set forth necessary but not sufficient conditions for the application of domestic securities laws to claims with foreign elements.  The court found that, while the Parkcentral Plaintiffs’ claims met the necessary condition of being based on a domestic transaction, they were not sufficiently “domestic” to justify the application of U.S. securities laws.  In particular, Plaintiffs’ claims were based on a German company’s statements, made primarily in Europe, regarding another German company whose shares were traded exclusively in Europe, and were the subject of an investigation by German regulatory authorities and litigation in German courts.  The court found that subjecting Porsche to litigation in the U.S. under these circumstances raised the potential for regulatory and legal overlap and conflict that Congress would not have intended and were inconsistent with the presumption against extraterritorial application of domestic laws.

The Second Circuit was careful to make clear that its decision was based only on the precise facts before it, and that it was not purporting to offer a new test to be used in applying Morrison to securities claims involving foreign elements in future cases.  The court’s opinion suggests that it does not believe that Morrison’s “clear test” is so clear after all, and leaves open the following question:  Where a claim satisfies Morrison’s necessary conditions for the application of domestic securities laws, what is required for that claim to be sufficiently “domestic” to warrant their application?  This question will likely continue to be litigated, in the Second Circuit and elsewhere.