A key feature of U.S. jurisprudence since the U.S. Supreme Court decided Morrison v. Nat'l Australia Bank Ltd in 2010 has been the shrinking reach of U.S. law. Applying Morrison, U.S. courts, including the Supreme Court, limited the extraterritorial reach of U.S. law across a number of substantive areas ranging from commodities regulation to human rights to RICO. Morrison and its progeny provided a powerful weapon for non-U.S.-based clients to resist the reach of U.S. courts, and many clients structured their affairs to take advantage of the reinvigorated presumption against the extraterritorial application of law and minimize their U.S. litigation exposure.

Now, nearly 10 years later, there are signs that this trend may be reversing. Recent decisions from the U.S. Courts of Appeals for the Second and Ninth Circuits have shown a willingness to allow claims based on conduct occurring outside the United States to survive dismissal at the pleading state. Time will tell whether these decisions are a sign of what is to come, or merely an exception to the ongoing trend to limit U.S. law's extraterritorial reach. However, the renewed willingness of U.S. courts to sustain claims involving obviously extraterritorial conduct—based on little more than a scintilla of a U.S. connection—should concern non-U.S. clients and their lawyers alike, and re-emphasize the importance of structuring corporate organizations and transactions so as to minimize litigation risk, both substantively and geographically.

'Morrison' Reaffirms the Presumption Against Extraterritorial Application of Law. Prior to 2010, the extraterritorial scope of the anti-fraud provisions of the Securities Exchange Act of 1934 were regulated by the so-called “conduct and effects” test, a complex, multi-factor analysis applied by the circuit courts. The test required judges to consider where conduct occurred and where the conduct's effects were felt, and then apply a sliding scale to determine whether plaintiffs should be permitted to seek redress in American courts. The result was an unpredictable hodge-podge of decisional authority that encouraged expensive litigation and led to sweeping assertions of U.S. judicial power abroad. In deciding Morrison, the Supreme Court sought to put an end to this approach.

In Morrison, the Supreme Court admonished the lower courts that their role was only to give a statute “the effect its language suggests … not to extend it to admirable purposes it might be used to achieve.” Morrison, 561 U.S. at 270. The Supreme Court famously declared that “[w]hen a statute gives no clear indication of an extraterritorial application, it has none.” Id. at 255. Morrison identified a two-step analytical framework to determine whether the foreign conduct alleged in a complaint was actionable in the United States. First, a court must examine whether the statute in question gives an affirmative indication that it applies to foreign conduct. If there is no such indication, the court must then determine whether domestic application of the statute is implicated by the case's facts. This is done by examining the statute's “focus.” Id. at 266. If the court finds that conduct relevant to the statute's focus took place domestically, then the statute can be applied even if some conduct was foreign. See RJR Nabisco v. European Cmty., 136 S. Ct. 2090, 2101 (2016).

Finding that Congress did not express any extraterritorial intent in the Exchange Act, Morrison held that the Act applied only to securities traded on a domestic exchange or domestic transactions in other securities. Morrison, 561 U.S. at 267.

Morrison quickly became “one of the most frequently cited decisions” of the 2009-2010 court term and “worked a revolution in what had been a burgeoning area of securities litigation.”[1] In the years which followed, Morrison's effects were felt far beyond the Exchange Act: Morrison was used to curtail the reach of the Stored Communications Act, the Alien Tort Statute, the Commodities and Exchange Act, and the Bankruptcy Code.[2] And that's only a sample.

So strong was the inclination to follow Morrison that at least one court applied the presumption even where the transaction at issue had allegedly taken place within the United States. In Parkcentral Glob. Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198 (2d Cir. 2014), the Second Circuit was called to consider whether investors in swap agreements allegedly created, marketed, and purchased in the United States—which referenced VW's foreign-traded shares—could bring claims based on Porsche's alleged scheme to acquire VW. The Second Circuit held that notwithstanding the plaintiffs' execution of the swap agreements in the United States, their claims were barred by the extraterritoriality presumption because Porsche's allegedly fraudulent transaction was “so predominantly foreign as to be impermissibly extraterritorial.” Parkcentral, 763 F.3d at 216.

The result of Morrison's progeny was a shortened reach of U.S. law to conduct occurring outside the United States.

Circuit Courts Pivot Away From 'Morrison'. Now, nearly a decade since the Supreme Court decided Morrison, there are some signs that U.S. courts—at least at the circuit court level—are ready to re-examine exactly how restrictive the extraterritoriality presumption should be. Two recent decisions—from different judicial circuits—may suggest that the pendulum is swinging back.

Myun-Uk Choi v. Tower Research Capital, 890 F.3d 60 (2d Cir. 2018), involved transactions on a futures market administered by Korea Exchange (KRX), a securities exchange headquartered in South Korea. To facilitate after-hours trading of futures contracts, KRX contracted with CME Globex, a U.S.-based company, to operate a “night market” on its electronic trading platform. Under this arrangement, certain orders were placed on KRX's system in Korea and then electronically sent to CME, which matched the orders with counterparties. After matching, the trades were settled the following day by KRX in Korea.

Plaintiffs, all Korean citizens, alleged that a U.S.-based high-frequency trading firm violated the Exchange Act by engaging in “spoofing,” a form of trading wherein high-frequency trading technology is used to place and immediately cancel large volumes of orders for the alleged purpose of moving a market. Brushing aside the lower court's finding that the plaintiffs' transaction in securities occurred in Korea, where they incurred irrevocable liability, the Second Circuit found that the matching done by CME was sufficient to render the transaction domestic. Choi, 890 F.3d at 68.

Choi suggests that even where, as in Choi, a plaintiff's securities transaction occurs outside the United States, the plaintiff may nevertheless have a claim if in the process of settling the transaction the foreign financial institution used U.S. intermediaries or exchanges. As clients and investors will seldom know how their broker settles their securities transaction, Choi opens up a new avenue that creative plaintiffs will no doubt use to bring securities claims.[3] For U.S. clients the importance is also clear, as Choi shows that domestic activity may well result in liability for orders placed on exchanges outside the United States.

Just two months later, the Ninth Circuit decided Stoyas v. Toshiba, 896 F.3d 933 (9th Cir. 2018), finding that a claim based on unsponsored ADRs issued in the name of a foreign corporation could survive dismissal. Toshiba, which expressly rejected the reasoning of Parkcentral, thereby creating a circuit split, made clear that a foreign securities issuer may face U.S. litigation exposure even if the foreign issuer abstained from listing its shares in the United States, either directly or through an American Depository Receipt (ADR) program.

Toshiba was brought by purchasers of Toshiba's unsponsored ADRs. Unlike sponsored ADRs, unsponsored ADRs can be created by a U.S. financial institution without the foreign issuer's involvement. Indeed, we have previously seen examples of foreign issuers learning that they have unsponsored ADRs from their litigation counsel years after the ADRs were created by a financial institution that had no business relationship with a foreign issuer.

In seeking dismissal of the complaint, Toshiba argued that it had no involvement in creating the ADRs and that because the conduct at issue occurred outside the United States, the claims were barred by the presumption against extraterritorial application of law. The district court sided with Toshiba, dismissing the plaintiffs' complaint as barred by the presumption against extraterritoriality, and noted plaintiffs' failure to provide “any evidence … of any affirmative act by Toshiba related to the purchase and sale of securities in the United States.” Stoyas v. Toshiba, 191 F. Supp. 3d 1080, 1095 (C.D. Cal. 2016). The Ninth Circuit reversed, holding that transactions in unsponsored ADRs could be “domestic.” Toshiba, supported by numerous amici, has sought Supreme Court review.

The Toshiba court may have been motivated by a unique fact pattern: injured U.S. plaintiffs and a suggestion that Toshiba may have attempted to game the system by consciously taking steps to support the non-sponsored ADRs, while being careful to avoid direct U.S. conduct.[4] In particular, the court may have been moved by plaintiffs' allegation that Toshiba created an English-language website to enable the issuance of the unsponsored ADRs and their further allegation—to be supported by discovery—that Toshiba worked behind the scenes with the financial institution issuing the ADRs. Thus, while the Court rejected plaintiffs' suggestion that Toshiba's publication of its financial statements in English—a step required to have an unsponsored ADR program—alone was sufficient to trigger application of the Exchange Act, it made clear that if plaintiffs could produce evidence that Toshiba took active steps to support unsponsored ADR program, their claim could proceed.

Lessons From 'Choi' and 'Toshiba'. Toshiba has sought Supreme Court review, and defendants in the Madoff litigations will no doubt do likewise later this summer. Thus, it is possible that we will get further guidance from the Supreme Court concerning the proper scope and import of the extraterritoriality presumption. In the meantime, Choi and Toshiba offer a number of lessons that foreign financial institutions and corporations, and their counsel, should consider.

To minimize—although not eliminate—that risk, foreign financial institutions and corporations should carefully consider how they structure their transactions, and financial market participants should carefully consider with whom and how they transact. In particular, foreign financial institutions and corporations may wish to consider express contractual provisions stating that irrevocable liability occurs outside the United States. Similarly, foreign issuers who do not wish to have ADR programs, but who are required to publish their financial statements in English, may want to consider appropriate disclaimers. Whether such actions ultimately help in defending against U.S. claims remains to be seen; but with the ever-increasing cost of U.S. litigation, and comparatively greater exposure that companies face if sued in the United States, an ounce of prevention may well be worth more than a pound of cure later on.

With U.S. courts potentially poised to reconsider the reach of the extraterritoriality presumption, defendants may increasingly rely on personal jurisdiction arguments to seek early dismissal of U.S. litigation. In the United States, recent Supreme Court and circuit court decisions have substantially shifted when, and how, U.S. courts will exercise jurisdiction over foreign defendants. Clients may therefore wish to reconsider their corporate structures, division of responsibilities, and U.S.-based conduct to ensure that they do not inadvertently undermine their jurisdictional defenses.

Finally, regardless of whether the Supreme Court chooses to weigh in on these issues in the near term, the law in this area is likely to develop, and may vary circuit-to-circuit. With Parkcentral still good law in the Second Circuit, plaintiffs may well choose to bring their unsponsored ADR claims in the Ninth Circuit where they will benefit from the Toshiba precedent. Further decisional authority will no doubt shift litigation incentives for plaintiffs and defendants alike, and foreign clients and their counsel may wish to keep careful track of these developments.

Endnotes:

[1] George T. Conway III, Postscript to Morrison v National Australia Bank, NYLJ, Oct. 14, 2010 at 5.

[2] See Kiobel v. Royal Dutch Petroleum Co., 569 U.S. 108 (2013); Matter of Warrant to Search a Certain E-Mail Account Controlled & Maintained by Microsoft Corp., 829 F.3d 197 (2d Cir. 2016); Loginovskaya v. Batratchenko, 764 F.3d 266 (2d Cir. 2014); Sec. Inv'r Prot. Corp. v. Bernard L. Madoff Inv. Sec., 513 B.R. 222, 229 (S.D.N.Y. 2014).

[3] As Judge Rakoff of the Southern District of New York observed in a different context, the law does not impose a duty on an investor to investigate the broker through which it trades, and, indeed, an investor may have limited ability to conduct any meaningful investigation of the brokers' system for matching and clearing transactions. Sec. Inv'r Prot. Corp. v. Bernard L. Madoff Inv. Sec., 516 B.R. 18, 22 (S.D.N.Y. 2014).

[4] This reading of Toshiba may suggest a willingness by U.S. courts to take steps to protect U.S. plaintiffs. This understanding is bolstered by a recent panel of the Second Circuit, which reversed rulings of the district and bankruptcy courts that had dismissed claims brought by the trustee in the liquidation the estate of Bernard L. Madoff Investment Securities as impermissibly extraterritorial. In re Picard, Tr. for Liquidation of Bernard L. Madoff Inv. Sec., 917 F.3d 85 (2d Cir. 2019). During oral argument, at least one judge of the Second Circuit expressed concern that dismissal of the trustee's claims would hinder the trustee's efforts to maximize recoveries for the victims of Madoff's Ponzi scheme.

Linda Martin is a partner and David Livshiz is counsel at Freshfields Bruckhaus Deringer.