Companies outside the US should familiarise themselves with internal investigation practices as part of a package of measures to guard against suits filed in the US

According to a recent study by PricewaterhouseCoopers, the number of securities class actions filed in the US against non-US companies hit an all-time high in 2008. Numerous factors contributed to this trend, and none show signs of reversing any time soon. European companies can reduce their exposure to the risk of US securities litigation by employing preventative measures, including best practices for internal investigations.

Factors contributing to trend

One factor contributing to the trend towards US securities litigation against non-US companies has been increased participation by European institutional investors. German institutions have been particularly active, seeking the lead role in US securities class actions over 50 times. In addition, an upsurge in activity by UK pension funds was noted after a 2007 statement from the National Association of Pension Funds (NAPF) encouraging pension funds to participate in US securities litigation.

The global nature of the credit crisis also played a role. In 2008, financial institutions replaced tech companies as the top target of US securities class actions. Targeted companies include many well-known European names such as Credit Suisse, Deutsche Bank, and Royal Bank of Scotland. That is not to say that companies in the often-targeted tech and pharmaceutical sectors escaped suit in recent years, as evidenced by suits against Vodafone, GlaxoSmithKline, and others.

Greater scrutiny by the US Securities and Exchange Commission (SEC) likely contributed as well. In 2008, the SEC made 556 requests for investigative assistance to non-US regulators, a far higher number than in any previous year. Greater attention from the SEC increases the risk of a class action, as private plaintiffs frequently bring suit concurrently with or subsequent to an SEC investigation.

Risk remains despite Morrison decision

The trend towards US securities class actions against non-US companies is unlikely to cease despite an October 2008 ruling regarding the US courts' jurisdiction over such claims. In Morrison v National Australia Bank, a federal appellate court upheld a finding of no jurisdiction over claims brought in New York by non-US residents who purchased securities of an Australian bank traded on exchanges outside the US.

Morrison did not put an end to future US securities class actions against non-US companies. For one thing, Morrison did not address claims by US residents who purchase securities on non-US exchanges. Nor did it address claims by non-US resident who purchase securities on US exchanges.

Instead, Morrison involved only the question of jurisdiction over claims by non-US residents who purchase securities in non-US companies on non-US exchanges. Such claims are known as 'f-cubed' in the US, as they are foreign to US courts in three ways – the residence of the plaintiff, the status of the corporation, and the location of the exchange where the securities were purchased.

Even when it comes to f-cubed claims, Morrison binds only those courts within the US Second Circuit, which includes federal courts in New York, Vermont, and Connecticut. In 2008, New York was the most popular site for US securities suits against non-US companies. The US securities laws permit nationwide venue, however. If New York courts begin relying on Morrison to dismiss f-cubed claims, plaintiffs' lawyers may shift to other states.

In addition, Morrison did not announce a bright-line rule prohibiting US jurisdiction over f-cubed claims. Rather, the court decided the case on the circumstances before it, finding no jurisdiction because the "heart" of the allegedly fraudulent scheme occurred in Australia, rather than in the US. This approach leaves the door open for f-cubed plaintiffs in other cases to argue that their circumstances differ from those in Morrison.

Greater clarity of the law may emerge as more cases work their way through the appellate courts or if US lawmakers address the issue. In the meantime, European companies should expect continued risk of suit in the US and prepare accordingly.

Preventative measures

Sound internal controls, effective training and compliance programs, and appropriate D&O insurance reduce litigation risk or position the company for a stronger defence should litigation occur. In addition to these measures, companies should familiarise themselves with best practices for internal investigations.

Internal investigations offer numerous potential benefits in preventing or defending US litigation. An internal investigation can avert litigation by allowing a company to discover and correct small problems on its own before they become big ones. A properly conducted internal investigation also may serve as the basis for a successful motion to dismiss a US derivative suit. In addition, conducting an internal investigation, disclosing the results to the SEC, and taking appropriate remedial action can help a company avoid charges by the SEC or lead to reduced charges.

At the same time, internal investigations that fail to employ best practices are of little benefit. Enron and other companies learned that lesson when they used their regular outside counsel to conduct internal investigations, only to have the results rejected for lack of independence.

An extensive body of best practices has developed to reflect the standards applied by US regulators and courts in evaluating internal investigations. These address topics such as structuring the investigation, retaining counsel, interviewing witnesses, evaluating the evidence, and reporting conclusions. Along with other preventative measures, European companies can use these practices to reduce their risk of US securities litigation.

Terri Garland is a litigation partner at Morrison & Foerster in San Francisco.