State pension fund investors can be such whiners. For the past two years they have chafed at a U.S. Supreme Court opinion holding that federal securities laws do not apply to transactions on foreign exchanges. (Morrison v. Nat'l Australia Bank, Ltd.
, 130 S. Ct. 2869 (2010).)
The opinion, written by Justice Antonin Scalia for a divided court majority, overturned twin tests devised by the federal courts for applying Section 10(b) of the Securities Exchange Act to misconduct by foreign companies, despite the absence of explicit language in the statute permitting it. Under one of the tests, an investor could bring a claim if a sufficient level of conduct occurred in the United States. Under the other, a claim would have to be supported by sufficient effects of the fraud on U.S. investors. Justice Scalia's approach was characteristically direct: "When a statute gives no clear indication of an extraterritorial application, it has none," he wrote. "On its face, Section 10(b) contains nothing to suggest that it applies abroad." (130 S. Ct. at 2873, 2881.) The Court majority substituted a "transactional test," based solely on where a security was purchased or sold.
Congress reacted immediately by adding two amendments to the then-pending Dodd-Frank Wall Street Reform and Consumer Protection Act. It reasserted SEC and Department of Justice extraterritorial jurisdiction under Section 10(b), using the established "conduct" and "effects" tests. But it left private plaintiffs hanging, directing the SEC to study whether it should reinstate a private right of action.
In the comment period, CalPERS reported to the SEC that it had more than $63 billion invested in international equities, mostly in ordinary shares bought on foreign exchanges. CalSTRS noted that it trades in approximately 62 foreign markets, with a total volume of more than $33 billion. Both funds complained that Morrison
had stripped them of the protections of the federal anti-fraud laws despite their fiduciary duty to manage diversified portfolios.
Since the Court's June 2010 ruling, claims by class members holding ordinary shares of foreign securities purchased on foreign exchanges have been tossed from a series of high-profile cases: Stackhouse v. Toyota Motor Co.
(2010 WL 3377409 (C.D. Cal.)); In re Vivendi Universal, S.A. Sec. Litig.
(765 F. Supp. 2d 512 (S.D.N.Y. 2011)); and In re: BP p.l.c. Sec. Litig.
(2012 WL 432611 (S.D. Tex. 2012)).
In April the SEC released a 106-page report that simply listed congressional options, including doing nothing. But in a dissenting statement, SEC Commissioner Luis A. Aguilar recommended a return to private enforcement under the previous relevance tests. "The evidence post-Morrison
is stark and compelling," Aguilar wrote. "All of the predictions of the harm that the Morrison
decision would inflict on investors have come to pass."
"They punted," says Joseph J. Tabacco Jr., managing partner of Berman DeValerio's San Francisco office. "The SEC leaves a gaping hole in the securities laws."
So what's an investor in foreign securities to do? "We don't think there are any work-arounds," says Michael D. Torpey, partner in the San Francisco office of Orrick, Herrington & Sutcliffe and chair of the firm's Securities Litigation Group. "The statutory scheme doesn't lend itself to work-arounds - there is no state court jurisdiction over Rule 10(b)-5. There's no fix for Morrison
Congress had enacted the Securities Litigation Uniform Standards Act of 1998 specifically to preempt plaintiffs from filing class actions alleging fraud under state law. "Under SLUSA, class actions for a 'covered security' listed on the New York Stock Exchange will be bumped to federal court," says Mary K. Blasy, a partner in the San Diego office of Scott + Scott. "If you can't proceed under Section 10(b), there will be an automatic dismissal."
But there are still options: Under SLUSA, plaintiffs can file a "group action" covering 50 or fewer people for common law fraud in state court. And under Morrison
, purchasers of a foreign company's American Depositary Receipts (ADRs) offered on U.S. exchanges can file under Rule 10(b)-5 in federal court.
"We just filed an individual action against BP on behalf of the Ohio state attorney general and the Ohio pension funds in state court under state securities laws," Tabacco says. "It asserts claims by the Ohio funds for ordinary BP shares purchased on foreign exchanges, which were dismissed under Morrison
by the federal court in Houston." (Ohio Public Employees Retirement System v. BP p.l.c.
No. CV-12-780843 (Ohio Ct. C. P. (Cuyahoga Cny.) filed April 19, 2012).)
Matthew K. Edling, a principal in the Burlingame office of Cotchett, Pitre & McCarthy, says his firm also filed claims against BP in April in the federal litigation on behalf of Ohio and New York pension funds holding BP's ADRs. "Pension funds can be lead class representatives for ADRs in federal court, and also seek common law fraud claims in state court," Edling says. "But because we cannot allege a Rule 10(b) claim in state court, we are not afforded fraud-on-the-market theory."
Plaintiffs lawyers in New York are pursuing similar strategies. After the federal court dismissed a case brought by an Australian hedge fund against Goldman Sachs involving a collateralized debt obligation called Timberwolf - famously characterized by a former Goldman executive as a "sack of shit" - the plaintiffs skirted Morrison
by filing in the Supreme Court of New York under common law causes of action. (Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc.
, No. 652996/2011(N.Y. Sup. Ct. filed Oct. 27, 2011).)
Adding to the possibilities, the New York Court of Appeals ruled unanimously last year that the state's Martin Act - the nation's toughest "blue sky" state securities law - does not bar private causes of action for claims of negligence and breach of fiduciary duty. (Assured Guaranty (UK) Ltd. v. J.P. Morgan Inv. Mgmt. Inc.
, 18 N.Y. 3d 341 (2011).) Whether the Martin Act has an extraterritorial reach, however, is still in doubt.
Orrick's Torpey is skeptical. "I don't believe there will be an effective state court alternative to Morrison
," he says. "The plaintiffs bar is actually thinking of moving out of the U.S. - they're finding more class members outside the U.S. anyway. Ontario, Canada, has a provincial securities law patterned after Section 10(b). It's plaintiff-friendly, includes a fraud-on-the-market theory, does not impose loser pays, and has the ability to certify global classes. The Netherlands also has a statute that can bind international defendants, at least in the EU."
So if you're a CalPERS or CalSTRS investor, you're left with a Hobson's choice: Do you buy ordinary shares of international securities cheaply on the London market, or do you pay more for the few ADRs listed on U.S. exchanges? If you trade in risky global markets, of course, you can always call a good plaintiff lawyer in Toronto or Amsterdam. Tell 'em Justice Scalia sent you.