City of Pontiac – Second Circuit defines limits on extraterritorial liability claims under Section 10(b) post-Morrison

Section 10(b) of the Exchange Act and the rules thereunder are the principal anti-fraud provisions of US securities law. In 2010, the U.S. Supreme Court issued an opinion in Morrison v. National Australia Bank[1] to the effect that Section 10(b) of the Exchange Act and Rule 10b-5 thereunder apply only in connection with a purchase or sale of a security listed on a domestic exchange, and the purchase or sale of any other security in the United States. (For more information on Morrison, please see the update by the Forum for US Securities Lawyers in London.

In City of Pontiac, the plaintiffs alleged that because the securities at issue were listed both on foreign exchanges and the NYSE (i.e., a domestic exchange), under Morrison, they should be subject to claims under Section 10(b) of the Securities Act. The Court rejected this “listing theory” on the basis that, despite the fact that the securities were listed on a domestic exchange, this did not subject them to liability under Section 10(b) of the Exchange Act pursuant to Morrison as this interpretation would be “irreconcilable with Morrison read as a whole”; the Court held that “Morrison does not support the application of [Section 10(b)] to claims by a foreign purchaser of foreign issued shares on a foreign exchange simply because those shares are also listed on a domestic exchange.”

The second point the Court addressed was whether placing a buy order in the United States exposes the transaction to potential Section 10(b) liability under the Morrison test. One of the plaintiffs, a US entity, purchased some of its securities on a foreign exchange, but placed the buy order from the United States. This plaintiff argued that its purchase met the Morrison test because it “constitute[d] a ‘purchase… of [a] security in the United States.” The Court noted that the test for determining whether a transaction is a domestic transaction for the purpose of Morrison is whether the party “incur[s] irrevocably liability to carry out the transaction within the United States or when title is passed within the United States.” [2] The Court determined that the placement of a buy order in the United States for the purchase of foreign securities on a foreign exchange is not sufficient to meet this test. The plaintiffs argued that as a US entity, its “irrevocable liability” was incurred where the buy order was placed; however, the Court rejected this and noted that neither citizenship nor residency of an entity determines where a transaction occurs.[3]In City of Pontiac, the Court has further limited the extraterritoriality of the Exchange Act, which should provide some comfort to foreign issuers, especially those with securities cross-listed on an exchange in the United States. While City of Pontiac provides a strict interpretation of the first prong of Morrison (i.e., transactions on a domestic exchange), there is still much potential ambiguity with respect to the second prong of Morrison (i.e., “the purchase or sale of any other security in the United States”). While City of Pontiac confirms that the mere placement of a buy order from within the United States is not sufficient to meet the second prong of Morrison, there are, of course, ample variations of this fact pattern in market practice that are yet to be tested.

[1] 561 U.S. 247 (2010).

[2] Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2012).

[3] Absolute Activist, 677 F.3d at 69.