Second Circuit Ruling Creates Challenge for Securities Class Action Plaintiffs

The Second Circuit recently considered the extraterritorial application of the U.S. securities laws in the private securities class action context, bringing some clarity to an area of the law that is increasingly important given the globalization of financial markets.

In re Petrobras Securities, 862 F.3d 250 (2nd Cir. 2017), was an appeal of a class certification order in a securities class action related to an alleged multi-year money-laundering and kickback scheme involving Petróleo Brasileiro S.A. (“Petrobras”), the Brazilian state-owned oil and gas company. The district court had certified two classes of investors who purchased Petrobras American Depository Shares (ADS) and debt securities, and who brought misrepresentation claims under the Securities Act of 1933 and the Securities Exchange Act of 1934 against Petrobras, its subsidiaries, and its underwriters. Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), held that the anti-fraud provisions of the securities laws have no extraterritorial effect, and as a consequence apply only to transactions in securities that occur on a U.S.-based exchange or that are otherwise “domestic.” Petrobras ADS shares satisfied the first requirement, but the company’s debt securities are traded over-the-counter, not on a U.S. exchange. Prior decisions had limited “domestic” transactions to ones where (1) the purchaser “incurred irrevocable liability within the United States to take and pay for a security . . . or to deliver a security” or (2) “legal title to the security . . . transferred in the United States” (see, e.g., Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 68 (2d Cir. 2012)), but how this test implicated the standards for class certification was not clear.

The Second Circuit thus began its discussion of class certification by identifying the facts that would be relevant to determining whether a transaction in Petrobras debt securities was “domestic.” It first noted that the “location or residency of the buyer, seller, or broker will not necessarily establish the situs of the transaction.” Rather, plaintiffs were required to come forward with evidence “including, but not limited to, facts concerning the formation of the contracts, the placement of purchase orders . . . or the exchange of money.” This recitation permitted the Second Circuit to assess how to apply class certification standards to transactions in securities that did not take place on a U.S. exchange. Addressing defendants’ argument that plaintiffs had failed to satisfy the “predominance” requirement of Rule 23(b)(3), the Second Circuit held that a “proper assessment of predominance” involved two predicate questions: (1) is the determination of domesticity material to the class claims; and, if so, (2) is that determination “susceptible to generalized class-wide proof such that it represents a common question rather than an individual one.” As to the first question, the Second Circuit found that Morrison made clear that domesticity was material because a putative class member only has a viable cause of action if the security at issue was purchased in a qualifying transaction. And the Second Circuit found that the district court had failed to “meaningfully” address the second question because it did not give “careful scrutiny to the relation between the common and individual questions central to this case.” Remanding the case for a proper predominance analysis, the Second Circuit noted that, “[o]n the available record, the investigation of domesticity appears to be an individual question requiring putative class members to present evidence that varies from member to member.” Moreover, the “potential for variation across putative 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—appears to generate a set of individualized inquiries.” Unless plaintiffs could offer class-wide evidence of domesticity, the fact-finder would have to look at every class member’s transaction to determine who did and did not have a valid claim, precluding resolution of the case on a class-wide basis.

The Second Circuit separately rejected defendants’ class certification challenge on “ascertainability” grounds, declining to adopt defendants’ proposed “freestanding administrative feasibility” requirement. Rather, “tak[ing] this opportunity to clarify” the law, the Second Circuit held that finding a class to be ascertainable” “requires only that a class be defined using objective criteria that establish a membership with definite boundaries”—a requirement found to have been satisfied. The Second Circuit separately affirmed the lower court’s finding that Petrobras securities traded in an efficient market and that plaintiffs were therefore entitled to a presumption of reliance on the market price of the securities.

The Petrobras decision will likely have a significant impact on securities class action claims involving securities transactions that did not take place on a U.S. exchange. By requiring a fact-based investigation of the circumstances surrounding those transactions, and by expressing evident skepticism that common facts would emerge, the Second Circuit gave putative representative plaintiffs a substantial burden to surmount.