Second Circuit Clarifies Rules Regarding Extraterritorial Enforcement of the Securities Exchange Act

On May 6, 2014, the Second Circuit clarified the rules regarding extraterritorial enforcement of the Securities Exchange Act of 1934 (“Exchange Act”), holding that persons who purchased shares of a foreign issuer on a foreign exchange could not bring suit under Section 10(b) in connection with that purchase even if the shares were cross-listed on a United States exchange. The decision is consistent with other recent opinions interpreting the Supreme Court’s opinion in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), and should give foreign issuers who cross-list in the United States further comfort that their liability under the Exchange Act will be capped by the number of shares that are bought or sold in the United States or on a United States exchange.

Four years ago, in Morrison, the Supreme Court held that Section 10(b) of the Exchange Act applies only to “(1) transactions in securities listed on domestic exchanges, and (2) domestic transactions in other securities.” Since the Morrison decision, the appellate decisions in the Second Circuit (the leading Circuit for securities law) have focused on the second prong – whether the plaintiff alleged or proved a domestic transaction. In Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2d Cir. 2012), the Second Circuit held that a securities transaction is domestic for purposes of Morrison’s second prong only when title is passed in the United States or irrevocable liability to carry out the transaction is incurred there (i.e., where the buyer and seller agree on the transaction, the buyer incurs the obligation to take and pay, and the seller incurs the obligation to deliver).

In City of Pontiac Policemen’s and Firemen’s Retirement System v. UBS AG, No. 12-4355-cv (2d Cir. May 6, 2014), the Second Circuit answered two related questions: (1) does the Exchange Act apply to a transaction effected on a foreign exchange in a security that is also cross-listed in the United States; and (2) does a domestic purchaser effect a “domestic” transaction in a security when the purchaser places a buy order with a broker in the United States when the transaction to purchase the shares is later executed on a foreign exchange. It answered both questions in the negative. First, the Court held that Morrison’s focus is on transactions in the United States. Accordingly, it was irrelevant that the particular security was cross-listed in the United States if a foreign purchaser purchased those shares on a foreign exchange. Second, the Court held that the fact that a buy order is placed in the United States does not, without more, establish that irrevocable liability was incurred in the United States and that it is the location where irrevocable liability is created, and not the location where the order is placed, that is determinative for Morrison’s second prong. In so holding, the circuit Court also made clear that the fact that a purchaser is a U.S. entity does not affect whether a transaction is domestic or foreign for purposes of the Exchange Act.

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