Second Circuit Broadens "Predominantly Foreign" Exception, Limiting Reach of U.S. Securities Laws
The Situation: In 2010, in Morrison v. National Australia Bank Ltd., the Supreme Court held that Section 10(b) of the Securities Exchange Act of 1934 applies to (i) "transactions in securities listed on domestic exchanges"; and (ii) "domestic transactions in other securities." In 2014, the Second Circuit created an exception to the "domestic transactions" prong of Morrison, holding that some claims are "so predominantly foreign" that the Exchange Act should not be applied. That left the question: what makes a claim "predominantly" foreign?
The Result: On January 25, 2021, the Second Circuit invoked its "predominantly foreign" exception to Morrison and affirmed the dismissal of the Section 10(b) claim in Cavello Bay Reinsurance v. Stein, notwithstanding that the claim concerned alleged misstatements emanating from New York and a subscription agreement countersigned by the defendants in New York.
Looking Ahead: While prior decisions applying the "predominantly foreign" exception suggested that it might be limited to complex structured finance transactions and misconduct that occurred exclusively abroad, Stein supports a broader reading of the exception. Thus, even claims that have substantial domestic components may nonetheless be viewed as "predominantly foreign" and beyond the reach of Section 10(b).
The State of Second Circuit Law Prior to Stein
In Parkcentral Global HUB Ltd. v. Porsche Automobile Holdings SE, the Second Circuit created an exception to the "domestic transactions" prong of Morrison by holding that some claims "are so predominantly foreign as to be impermissibly extraterritorial." However, the Second Circuit attributed its holding in Parkcentral to "the particular character of the unusual [securities-based swap agreements] at issue" and the "defendants' largely foreign conduct," and it did not apply the "predominantly foreign" exception again for approximately five years.
The Second Circuit next applied the "predominantly foreign" exception in Prime International Trading, Ltd. v. BP P.L.C. ("Brent Crude") in 2019, and in doing so, the court highlighted that the case also involved complex derivatives transactions and largely foreign alleged misconduct. Thus, prior to Stein, it appeared that the "predominantly foreign" exception would be invoked sparingly, and would not impact garden variety securities claims with significant domestic components.
Cavello Bay Reinsurance v. Stein
In Stein, the plaintiff, a Bermudan corporation, alleged that it had purchased shares in a Bermudan holding company that operated out of New York and invested in U.S. insurance services. The plaintiff claimed that the defendants made misstatements regarding the management fees that the holding company would pay an affiliate in both a telephone call (which the defendants participated in from New York) and in a PowerPoint presentation (which the defendants sent from New York). The Second Circuit acknowledged that the transaction "arguably took place in the United States," as the defendants countersigned the subscription agreement at issue in New York. The court nonetheless concluded that the plaintiff's claims were "predominantly foreign" and therefore outside the reach of Section 10(b). The Second Circuit focused on the fact that:
- The dispute involved a foreign plaintiff investing in a foreign issuer;
- The purchase was made in connection with a private offering; and
- The shares were not registered with the U.S. Securities and Exchange Commission, listed on a U.S. exchange or otherwise traded in the U.S.
The court concluded that providing a U.S. forum for the dispute would not "enhance confidence in U.S. securities markets or protect U.S. investors." However, the Second Circuit's reasoning seems to focus on the characteristics of the transaction, whereas the court's prior applications of the "predominantly foreign" exception in Parkcentral and Brent Crude focused on the details of plaintiffs' claims (i.e., where the alleged misconduct occurred).
Three Key Takeaways
- The Second Circuit's decision in Stein appears to have expanded the scope of the "predominantly foreign" exception, and will likely result in the dismissal of more securities fraud claims on extraterritoriality grounds.
- Defendants facing securities claims should carefully evaluate any foreign components of the claims to determine whether they might qualify as "predominantly foreign" under Stein.
- The "predominantly foreign" exception has been criticized by the Ninth Circuit as inconsistent with Morrison's stated preference for a "clear test" for the territorial application of Section 10(b), but the Supreme Court declined to address the circuit split in Brent Crude and it is unclear whether it will do so in Stein. Until the split is resolved, other circuit courts will be left to decide whether to adopt the Second Circuit's "predominantly foreign" exception.
Céalagh P. Fitzpatrick, an associate in the New York Office, assisted in the preparation of this Commentary.