Yesterday, the SEC asked Judge Barbara Jones to reinstate certain securities fraud claims against Goldman Sachs trader Fabrice Tourre relating to the sale of CDO notes to IKB, a German financing bank. Judge Jones dismissed these claims last June because the transaction was not a “domestic securities transaction” under the Supreme Court’s 2010 decision in Morrison v. National Australia Bank Limited, 130 S. Ct. 2869 (2010). It fell outside Section 10(b) of the Exchange Act. The SEC asserts in its motion that a recent Second Circuit case adopted a “broader” definition of “domestic securities transaction” than Judge Jones and that under that broader definition, the sale is a “domestic securities transaction” subject to U.S. law. According to the SEC, in Absolute Activist Master Fund Limited v. Ficeto, 672 F.3d 143 (2d Cir. 2012), the Second Circuit held that a transfer of title to securities within the United States is sufficient to satisfy the “domestic securities transaction” test. The SEC claims that the closing of the CDO transaction took place in New York and that title to the notes also transferred in New York. Based on the alleged transfer of title within the U.S., the SEC contends that it should be allowed to pursue its fraud claims against Tourre arising from the sale of the notes.
The Absolute Activist decision is an interesting one. In Morrison, the Supreme Court limited the extraterritorial reach of Section 10(b), holding that it applied only to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities.” The Court rejected the “conduct and effects” test that courts had previously applied, imposing instead a “transactional test.” The focus of the Exchange Act, the Court stated, “is not upon the place where the deception originated, but upon purchases and sales of securities in the United States.” For securities that are listed and traded on exchanges, the key question is whether the security is listed on a domestic exchange. If it is, it is covered by U.S. law. If not, it falls outside. But as Judge Jones noted in her June 2011 order dismissing certain of the SEC’s claims against Tourre, the Supreme Court provided little guidance as to what constitutes a purchase or sale made in the United States for securities that are not traded on domestic exchanges. That is the situation the Second Circuit faced in Absolute Activist. And in answering the question, the Second Circuit held that transactions involving securities that are not traded on a domestic exchange are domestic transactions within Section 10(b) if “irrevocable liability” for payment or delivery of the security is incurred in the United States or if “title passes within the United States.” As a recent DealBook article observed, this holding appears to revert to a “conduct and effects” test, which the Supreme Court rejected in Morrison. The Second Circuit will have another chance to address these issues in Viking Global Equities LP v. Porsche Automobile Holdings SE, No. 11-397. There, a group of hedge funds sued Porsche, claiming they lost $2 billion on swap agreements purchased in the United States on Volkswagen shares, which are traded on a German exchange. The hedge funds allege that Porsche purchased almost all the available ordinary shares of Volkswagen stock as part of a plan to take over the company despite public statements that it had no intention to do so. According to the hedge funds, when Porsche revealed its holdings, the price of the Volkswagen shares rose dramatically, resulting in substantial losses for the hedge funds, which stood to profit from a decline in the share price. Judge Harold Baer dismissed the hedge funds’ claims in December 2010, ruling that Morrison barred them. Because the swaps referenced a security traded on a foreign exchange, they “were the functional equivalent of trading the underlying VW shares on a German exchange.” The “economic reality,” according to Judge Baer, was that the swap agreements were “essentially ‘transactions conducted upon foreign exchanges and markets’” thereby falling outside the protection of the U.S. securities laws. On appeal, the hedge funds have argued that because the transactions occurred in the United States, they are subject to U.S. law. The Second Circuit held argument in February. The case is under submission.