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The Supreme Court has never considered whether the anti-fraud provisions of U.S. securities law extend to “foreign-cubed” (F-cubed) securities lawsuits. F-cubed suits occur when foreign purchasers of securities sue foreign issuers for violations of American securities laws with respect to securities traded on a foreign exchange.

It's not that these lawsuits have failed to attract appellate courts' attention. And the courts haven't quite managed to agree on what constitutes the appropriate test for assuming subject matter jurisdiction over such lawsuits.

Indeed, three approaches exist. The D.C. Circuit's is the most restrictive, requiring that the conduct in the U.S. amounts to a securities violation before the court will take jurisdiction. By contrast, the 3rd, 8th and 9th circuits demand only that “some activity designed to further a fraudulent scheme” occur in the U.S. For its part, the 2nd Circuit has taken a middle-of-the-road position requiring that domestic acts must be “at the heart” of the fraud before U.S. courts may act.

“The jurisprudence has become a checkerboard, and that makes it difficult to predict when the courts will take jurisdiction,” says Jeff Golenbock, a partner at Golenbock Eiseman Assor Bell & Peskoe.

But on Nov. 30, 2009, the Supreme Court indicated it was prepared to address the split. It agreed to review Morrison v. National Australia Bank Ltd., a decision in which the 2nd Circuit affirmed its “at the heart” test and explicitly rejected a bright-line rule that would prohibit F-cubed lawsuits whenever the impugned conduct had no effect in the U.S. or on American investors.

“This issue will arise with increasing frequency as the shareholder base becomes ever more global,” says Dan Kramer, a partner at Paul, Weiss, Rifkind, Wharton & Garrison. “So it's important that the court provide guidance as to how judges should analyze future cases.”

Morrison Matters

Morrison, it appears, is tailor-made for the analysis.

The shareholder plaintiffs, all of whom purchased their shares abroad, alleged that National Australia Bank (NAB), the country's largest bank, had falsely inflated the potential fee income of an American subsidiary, Florida-based mortgage service provider HomeSide Lending Inc.

The bank's common stock traded on the Australian Securities Exchange, the London Stock Exchange, and the Tokyo and New Zealand exchanges. The shares did not trade on U.S. exchanges, but NAB's American Depository Receipts (ADRs, or instruments issued by U.S. depository banks that give holders the right to buy the foreign stock) did trade on the New York Stock Exchange.

NAB had acquired HomeSide, America's sixth biggest mortgage service company with the right to service mortgages totaling $18 billion in 1998.

During the next two years, NAB reported HomeSide had generated about 5 percent of the bank's total profits of $5.6 billion. HomeSide calculated its profits by using a valuation model that amortized the value of its mortgage servicing rights over the expected life of the rights.

In 2001, NAB announced that HomeSide's valuation model was flawed. It recalculated the profit, producing a $450 million write-down. Both NAB's shares and its ADRs fell more than 5 percent on the news. A subsequent $1.75 billion write-down caused the shares to drop 13 percent while the ADRs fell more than 11.5 percent.

The plaintiffs sued NAB, HomeSide and various individual officers and directors in the Federal District Court for the Southern District of New York. They claimed HomeSide used unreasonably optimistic valuation assumptions or methodologies and that the defendants made materially false and misleading statements in NAB's SEC filings, annual reports and press releases.

The plaintiffs also alleged that HomeSide falsified the data in Florida, then sent it to NAB in Australia, where the parent disseminated the material in public filings and statements.

The defendants moved to dismiss for lack of subject matter jurisdiction. The district court ruled for the defendants. An appeal to the 2nd Circuit followed.

A Second Look

The shareholders' case rested on the premise that the fraud occurred primarily in Florida because HomeSide was located there and created the false numbers there. The defendants countered that the fraud occurred in Australia, where NAB issued the fraudulent statements.

The court agreed with the defendants, ruling that the heart of the fraud occurred in Australia because NAB had primary responsibility for ensuring the accuracy of the statements. Indeed, HomeSide's numbers had to pass through various “checkpoints” manned by Australian personnel, and there was no evidence that HomeSide had sent material directly to investors.

“While HomeSide's rigging of the numbers may have contributed to the misinformation, a number of significant events needed to occur before this misinformation caused losses to investors,” the court stated.

The “striking absence” of allegations that the fraud affected U.S. markets or residents also influenced the court.

“[Plaintiffs] do not contend that what [the defendants] allegedly did had any meaningful effect on American's investors or its capital markets,” the court said.

Full Circle

The 2nd Circuit stopped short of calling that a standard, however, which may prove central to the Supreme Court's analysis of the issue.

While acknowledging that the “heart of the fraud” test would mandate case-by-case analysis of the impact of domestic conduct, the 2nd Circuit refused to opt for a bright-line test that ruled out F-cubed actions whenever the fraud had no effect in the U.S. or on American investors.

“[W]e are leery of rigid bright-line rules because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result in their being subject to American jurisdiction,” the court stated.

Whether the Supreme Court will agree remains to be seen.

“It's apparent from the grant of certiorari that at least some members of the court want to consider the possibility of a firm rule that will give certain additional guidance,” Golenbock says.

Whatever the result, a decision on F-cubed cases would bring securities class action jurisprudence from the high court full circle.

“In recent years, the Supreme Court has looked at loss causation, scienter and the Private Litigation Securities Reform Act of 1995,” says Chris Caparelli, of counsel at Torys. “F-cubed issues are an area into which the Supreme Court has not yet ventured, and dealing with them may give the court some sense that it's closing the loop on securities jurisprudence.”

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The Supreme Court has never considered whether the anti-fraud provisions of U.S. securities law extend to “foreign-cubed” (F-cubed) securities lawsuits. F-cubed suits occur when foreign purchasers of securities sue foreign issuers for violations of American securities laws with respect to securities traded on a foreign exchange.

It's not that these lawsuits have failed to attract appellate courts' attention. And the courts haven't quite managed to agree on what constitutes the appropriate test for assuming subject matter jurisdiction over such lawsuits.

Indeed, three approaches exist. The D.C. Circuit's is the most restrictive, requiring that the conduct in the U.S. amounts to a securities violation before the court will take jurisdiction. By contrast, the 3rd, 8th and 9th circuits demand only that “some activity designed to further a fraudulent scheme” occur in the U.S. For its part, the 2nd Circuit has taken a middle-of-the-road position requiring that domestic acts must be “at the heart” of the fraud before U.S. courts may act.

“The jurisprudence has become a checkerboard, and that makes it difficult to predict when the courts will take jurisdiction,” says Jeff Golenbock, a partner at Golenbock Eiseman Assor Bell & Peskoe.

But on Nov. 30, 2009, the Supreme Court indicated it was prepared to address the split. It agreed to review Morrison v. National Australia Bank Ltd., a decision in which the 2nd Circuit affirmed its “at the heart” test and explicitly rejected a bright-line rule that would prohibit F-cubed lawsuits whenever the impugned conduct had no effect in the U.S. or on American investors.

“This issue will arise with increasing frequency as the shareholder base becomes ever more global,” says Dan Kramer, a partner at Paul, Weiss, Rifkind, Wharton & Garrison. “So it's important that the court provide guidance as to how judges should analyze future cases.”

Morrison Matters

Morrison, it appears, is tailor-made for the analysis.

The shareholder plaintiffs, all of whom purchased their shares abroad, alleged that National Australia Bank (NAB), the country's largest bank, had falsely inflated the potential fee income of an American subsidiary, Florida-based mortgage service provider HomeSide Lending Inc.

The bank's common stock traded on the Australian Securities Exchange, the London Stock Exchange, and the Tokyo and New Zealand exchanges. The shares did not trade on U.S. exchanges, but NAB's American Depository Receipts (ADRs, or instruments issued by U.S. depository banks that give holders the right to buy the foreign stock) did trade on the New York Stock Exchange.

NAB had acquired HomeSide, America's sixth biggest mortgage service company with the right to service mortgages totaling $18 billion in 1998.

During the next two years, NAB reported HomeSide had generated about 5 percent of the bank's total profits of $5.6 billion. HomeSide calculated its profits by using a valuation model that amortized the value of its mortgage servicing rights over the expected life of the rights.

In 2001, NAB announced that HomeSide's valuation model was flawed. It recalculated the profit, producing a $450 million write-down. Both NAB's shares and its ADRs fell more than 5 percent on the news. A subsequent $1.75 billion write-down caused the shares to drop 13 percent while the ADRs fell more than 11.5 percent.

The plaintiffs sued NAB, HomeSide and various individual officers and directors in the Federal District Court for the Southern District of New York. They claimed HomeSide used unreasonably optimistic valuation assumptions or methodologies and that the defendants made materially false and misleading statements in NAB's SEC filings, annual reports and press releases.

The plaintiffs also alleged that HomeSide falsified the data in Florida, then sent it to NAB in Australia, where the parent disseminated the material in public filings and statements.

The defendants moved to dismiss for lack of subject matter jurisdiction. The district court ruled for the defendants. An appeal to the 2nd Circuit followed.

A Second Look

The shareholders' case rested on the premise that the fraud occurred primarily in Florida because HomeSide was located there and created the false numbers there. The defendants countered that the fraud occurred in Australia, where NAB issued the fraudulent statements.

The court agreed with the defendants, ruling that the heart of the fraud occurred in Australia because NAB had primary responsibility for ensuring the accuracy of the statements. Indeed, HomeSide's numbers had to pass through various “checkpoints” manned by Australian personnel, and there was no evidence that HomeSide had sent material directly to investors.

“While HomeSide's rigging of the numbers may have contributed to the misinformation, a number of significant events needed to occur before this misinformation caused losses to investors,” the court stated.

The “striking absence” of allegations that the fraud affected U.S. markets or residents also influenced the court.

“[Plaintiffs] do not contend that what [the defendants] allegedly did had any meaningful effect on American's investors or its capital markets,” the court said.

Full Circle

The 2nd Circuit stopped short of calling that a standard, however, which may prove central to the Supreme Court's analysis of the issue.

While acknowledging that the “heart of the fraud” test would mandate case-by-case analysis of the impact of domestic conduct, the 2nd Circuit refused to opt for a bright-line test that ruled out F-cubed actions whenever the fraud had no effect in the U.S. or on American investors.

“[W]e are leery of rigid bright-line rules because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result in their being subject to American jurisdiction,” the court stated.

Whether the Supreme Court will agree remains to be seen.

“It's apparent from the grant of certiorari that at least some members of the court want to consider the possibility of a firm rule that will give certain additional guidance,” Golenbock says.

Whatever the result, a decision on F-cubed cases would bring securities class action jurisprudence from the high court full circle.

“In recent years, the Supreme Court has looked at loss causation, scienter and the Private Litigation Securities Reform Act of 1995,” says Chris Caparelli, of counsel at Torys. “F-cubed issues are an area into which the Supreme Court has not yet ventured, and dealing with them may give the court some sense that it's closing the loop on securities jurisprudence.”