The Extraterritorial Reach of the U.S. Courts Over Foreign Private Issuers,
Corporate & Finance Alert
November 25, 2008
The current turmoil in the credit markets and the volatility of the equity markets is likely to continue to spawn a variety of U.S. lawsuits against FPIs. Foreign investors are increasingly aware of U.S. class action procedures and the potential lucrative remedies available under the U.S. legal system. Accordingly, seeking to bring a claim before U.S. courts (instead of more obvious, and more appropriate, local courts) might be a very attractive proposition for foreign plaintiffs, and strategically something likely to increase the pressure on foreign companies.
An FPI needs to know whether a disgruntled non-U.S. shareholder can look to the U.S. courts for redress when there is otherwise little connection to the United States. Imagine, for instance, that: (1) a non-U.S. company which is not ordinarily subject to the jurisdiction of the U.S. courts, (2) a shareholder is also not a U.S. citizen, (3) the company intentionally does not list or actively trade its securities in the U.S. market, and (4) the shares were bought by the non-U.S. shareholder on a non-U.S. exchange.
In this scenario, should the FPI have a concern? Somewhat worryingly, the answer is “YES”, and a number of prominent FPIs have incurred significant costs litigating just these types of claims – called “foreign-cubed” or “F-cubed” claims – in recent years.
Most recently, in late October 2008, the Second Circuit Court of Appeals was confronted with the issue of F-cubed claims and issued an important decision regarding the extraterritorial application of the U.S. securities laws that will have broad implications for non-U.S. public companies. The Second Circuit appeals court is one of the most influential in the United States, and its decisions are binding on District Courts in New York (where many securities class actions are brought), and they often carry significant weight elsewhere in the United States.
In Morrison v. National Australia Bank, Ltd., three plaintiffs (“Foreign Plaintiffs”) had bought “ordinary shares” (the equivalent of American common stock) of the National Australia Bank, Australia’s largest bank (“NAB”). Those shares traded on a number of foreign exchanges — the Australian Securities Exchange, the London Stock Exchange, the Tokyo Stock Exchange and the New Zealand Stock Exchange but did not trade in the United States, and the Foreign Plaintiffs purchased their shares abroad.
Prior to the Foreign Plaintiffs’ purchases, NAB had acquired a United States corporation, HomeSide Lending, Inc. (“HomeSide”), a mortgage service provider headquartered in Jacksonville, Florida. NAB later discovered that HomeSide had engaged in accounting practices that resulted in an overstatement of the company’s financial results. NAB’s subsequent disclosure of this irregularity caused NAB’s ordinary shares to fall dramatically in value.
Although they had purchased their shares abroad, the Foreign Plaintiffs brought suit in federal district court in Manhattan, alleging violations of the federal securities laws, including Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 (all of which generally prohibit making fraudulent statements in connection with the purchase and sale of securities). The Foreign Plaintiffs claimed that HomeSide had falsified the pertinent data in Florida, and then sent the data to NAB in Australia, where NAB personnel disseminated it via public filings and statements, and that in reliance upon the misleading statements by NAB, they had purchased NAB shares to their detriment.
The Foreign Plaintiff’s argued that it was appropriate for the suit to be brought in the United States, because the fraud was caused by the conduct of HomeSide in producing false accounting information, which occurred in the United States. The argument was based on one of two tests that U.S. courts traditionally use in deciding whether to accept jurisdiction over securities fraud cases involving FPIs. Typically, U.S. courts accept jurisdiction where the fraudulent activity produces substantial “effects” in the United States, or where it results from “conduct” that takes place in the United States.
The District Court disagreed with the Foreign Plaintiffs and dismissed the claims due to a lack of jurisdiction. The Foreign Plaintiffs appealed to the Second Circuit, arguing essentially that the District Court should have found that the fraud occurred primarily in Florida because HomeSide was located there and the allegedly false numbers were created there. The Second Circuit disagreed, and affirmed the District Court decision. The Court cited three factors: (1) the fraudulent statements at issue emanated from NAB’s headquarters in Australia; (2) the lack of any effect on America or Americans; and (3) the lengthy chain of causation between HomeSide’s actions and the statements that reached investors.
NAB (and a number of interested third parties) argued to the Second Circuit that U.S. courts should adopt a bright-line rule and never accept jurisdiction over “foreign-cubed” securities fraud actions. The Second Circuit refused to go this far, ruling that the “conduct” test continued to apply. The Court of Appeals made it clear that the jurisdiction determination under the “conducts” test is highly fact specific.
The Court’s reluctance to pronounce a bright-line rule, the emphasis on the specific facts of each case and the recent spate of F-cubed litigation involving household names such as Royal Ahold, Royal Dutch Shell, Parmalat, Nortel Networks and Vivendi, means that the likelihood of FPIs being subject to F-cubed claims remains more than a mere possibility.
In light of this, FPIs can seek to minimize the risk of a U.S. court finding that it has jurisdiction over a “foreign-cubed” class action lawsuit directed against them. Some (or all) of the following measures may help:
- incorporating a forum selection clause in your constitutional documentation. The inclusion of such a clause was relevant and effective in the recent case of In re Alstom SA Securities Litigation. In this case, the U.S. Southern District declined to permit French, English or Dutch persons who purchased their shares on foreign markets to sue the corporation. The Court upheld the effectiveness of a clause in the company’s Articles of Association that provided that disputes between the shareholders and the company be submitted exclusively to the jurisdiction of the courts located in France;
- review internal procedures and controls to reduce the risk of material misstatements of information derived from U.S. sources;
- ensure that all public communications for non-U.S. investors are prepared and distributed outside the United States, even when they contain information relating to United States operations;
- so that non-U.S. investors cannot claim to rely on information that is communicated in the United States but is not available overseas, establish and maintain procedures to ensure that information is communicated outside the United States prior to or simultaneously with its communication in the United States; and
- limit U.S. employees from communicating financial and business information regarding the group.
Finally, the decision in National Australia Bank should be considered a positive step forward for FPIs and, if followed, should make it more difficult for plaintiff’s to bring F-cubed claims. The Second Circuit emphasized in its opinion that it is “an American court, not the world’s court, and [it] cannot and should not expend [its] resources resolving cases that do not affect Americans or involve fraud emanating from America.” Whether courts in the future take the same approach in similar cases remains to be seen.