Recent opinion by US court places strict limitations on securities fraud class actions brought by foreign investors against foreign companies | Practical Law

Recent opinion by US court places strict limitations on securities fraud class actions brought by foreign investors against foreign companies | Practical Law

Recent opinion by US court places strict limitations on securities fraud class actions brought by foreign investors against foreign companies

Recent opinion by US court places strict limitations on securities fraud class actions brought by foreign investors against foreign companies

by Herbert S. Washer and Christopher R. Fenton, Shearman & Sterling LLP
Published on 28 Jan 2009 • USA
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US Court of Appeals for the Second Circuit refuses jurisdiction over securities fraud class action, brought by foreign investors against a foreign company under the anti-fraud provisions of US securities laws, because the conduct at the centre of the alleged fraud did not take place in the US. The case could be a significant victory for foreign defendants and it is anticipated that it is likely to be followed by other federal courts.
Recently, a growing number of foreign companies have been hauled into US courts to defend themselves against allegations of securities fraud brought by foreign investors who purchased shares on foreign exchanges. These cases (often referred to as "foreign-cubed" class actions) have raised important questions about whether US courts have jurisdiction over such suits.
Although courts have been divided on this issue, the recent decision by the US Court of Appeals for the Second Circuit in Morrison v National Australia Bank Ltd., 547 F.3d 167 (2d Cir. 2008) (Morrison) should be viewed as a significant victory for foreign defendants.
In Morrison, the Second Circuit was asked to decide whether US courts had jurisdiction over a case involving alleged misrepresentations made in financial statements compiled and disseminated by National Australia Bank (NAB) (an Australian financial institution) in Australia that were based, in part, on numbers reported to it by HomeSide Lendings, Inc., a wholly-owned subsidiary based in the US. Although NAB's ordinary shares trade only on foreign exchanges, its American depository receipts trade on the New York Stock Exchange.
The Second Circuit dismissed the case against NAB on the ground that it could not exercise jurisdiction under these circumstances. Although unwilling to rule out the possibility that US courts could ever exercise jurisdiction over a foreign-cubed case, the Second Circuit explained that it would only be appropriate to do so in very limited circumstances where the "conduct [that] comprises the heart of the alleged fraud" occurred within the US.
That test was not satisfied in Morrison because:
  • NAB's financial statements were prepared at, and issued from, its foreign headquarters in Australia.
  • The wrongful conduct that occurred in the US did not directly cause the claimants' losses.
  • The misreported numbers had to first pass through NAB before reaching investors.
Morrison is significant because, like NAB, most foreign companies prepare and issue their financial statements from outside the US and, under the Second Circuit's standard, would likely not be subject to class actions brought by a worldwide class of investors alleging securities fraud under the anti-fraud provisions of the US securities laws. Although the Second Circuit's decision is only binding on federal courts in New York, Connecticut and Vermont, the Court's reputation as a leading authority on securities law makes it quite possible that other courts in the US will soon follow its precedent.