In monitoring securities cases filed around the country, I like to keep an eye out for regional trends. Historically, plaintiffs’ counsel respected the company defendant’s forum, filing in the federal court closest to the company’s headquarters. That is certainly not true today. Many plaintiffs’ firms initiate cases in New York or California—and sometimes, a seemingly random location—against companies headquartered elsewhere.
Sometimes, these firms file outside of the headquarters forum simply because their headquarters is there, which allows them to keep litigation expenses down and avoid splitting fees with another lawyer if local counsel in the headquarters form is be required. Along with targeting smaller companies in what I call “lawsuit blueprint” cases, this type of cost savings has allowed some smaller plaintiffs’ firms to hurdle the high barriers to entry in the plaintiffs’ securities class action market, beginning with the Chinese reverse-merger cases in 2010. These plaintiffs’ firms have used the business strategy and returns from those cases to continue filing securities class actions, mostly against smaller companies. This expansion of the securities class action plaintiffs’ bar is one of the most significant securities litigation developments of this decade.
But, often, these plaintiffs’ firms file in a particular jurisdiction for strategic reasons. Over the last two years, I have noticed a small surge in certain securities complaints filed in the Third Circuit, even where defendants appear to have little connection to the forum. In particular, there has been an uptick in the number of Third Circuit cases involving foreign defendants or overseas conduct and the purchase or sale of stocks traded in over-the-counter markets or on non-registered exchanges, including the Over-the-Counter Bulletin Board (“OTCBB”) and Pink Sheets. I believe this trend relates to the Third Circuit’s interpretation of the Supreme Court’s ruling in Morrison v. Nat’l Australia Bank, 561 U.S. 247 (2010).
Before Morrison was decided, the lower courts had applied a number of different tests in determining when and how to apply Section 10(b) of the Exchange Act to fraudulent schemes involving conduct outside the United States. In Morrison, the Supreme Court held that Section 10(b) has no extraterritorial application, and can only apply to two categories of transactions: (1) “transactions in securities listed on domestic exchanges”; and (2) “domestic transactions in other securities.”
While Morrison simplified the framework for applying Section 10(b) in cases that involve overseas conduct, it inevitably left open a number of important questions, which have been addressed in the years since by the courts of appeals. For a good recent discussion of post-Morrison issues, please see this March 6, 2017 guest post on Kevin LaCroix’s The D&O Diary by Wiley Rein’s David Topol and Margaret Thomas: “Post-Morrison Application of U.S. Securities Laws to Foreign Issuers.”
One such question is how the Morrison test applies in cases that involve non-domestic conduct and the purchase or sale of securities in OTC markets and on non-registered exchanges. Two years ago, the Third Circuit addressed this question in a criminal case, United States v. Georgiou, 777 F.3d 125 (3d Cir. 2015), in which the defendant, Georgiou, had been charged with participating in a stock fraud scheme that involved the purchase and sale of shares in US companies quoted on the OTCBB and the Pink Sheets. While Georgiou manipulated the price of these securities through offshore brokerage accounts, at least one of the fraudulent transactions in each target stock was executed with a market maker based in the United States.
Applying the first prong of Morrison, the Third Circuit held that none of the trades qualified as “transactions in securities listed on domestic exchanges,” because the OTBB and Pink Sheets are not among the eighteen national securities exchanges registered with the SEC. This reasoning has since been cited and adopted by several district courts outside the Third Circuit. See, e.g., In re Poseidon Concepts Sec. Litig., 2016 WL 3017395 (S.D.N.Y., May 24, 2016); Stoyas v. Toshiba Corp., 191 F.Supp.3d 1080 (C.D. Cal. 2016).
Turning to Morrison’s second prong, however, the Third Circuit concluded that the trades facilitated by US market makers were “domestic transactions,” because the purchaser or seller had incurred “irrevocable liability” for these trades in the United States. In other words, by working with a domestic market maker, a purchaser or seller makes a “commitment” to the transaction in the United States, which brings the transaction within the scope of Section 10(b). On this basis, the Third Circuit affirmed Georgiou’s securities fraud conviction.
The Third Circuit’s ruling as to the second prong of Morrison does not put it directly at odds with any other circuit. Yet by stating unambiguously that use of a domestic market maker renders a transaction “domestic,” Georgiou offers plaintiffs’ counsel more certainty than exists elsewhere.
The year before Georgiou was decided, the Second Circuit addressed a similar issue in Parkcentral Glob. Hub Ltd. v. Porsche Auto. Holdings SE, 763 F.3d 198 (2d Cir. 2014), but offered a more qualified ruling. Like the Third Circuit, the Second Circuit indicated that a transaction should be considered “domestic” if irrevocable liability was incurred in the United States. But while Georgiou suggests that Section 10(b) applies to all domestic transactions, Porche held that the domestic trades at issue in that case were beyond the territorial scope of the Exchange Act. “While a domestic transaction or listing is necessary to state a claim under Section 10(b),” Judge Leval argued, “a finding that these transactions were domestic would not suffice to compel the conclusion that the plaintiffs’ invocation of Section 10(b) was appropriately domestic,” and it would be a mistake to “treat[ ] the location of a transaction as the definitive factor in the extraterritoriality inquiry.”
Porche involved an unusual fact pattern—foreign defendants, largely foreign conduct, and domestic trading in swaps tied to foreign securities—and it may be advisable to read the Second Circuit’s opinion narrowly. See, e.g., Poseidon, 2016 WL 3017395 at *12-13 (holding that Porche was inapposite where plaintiff had purchased domestically a foreign stock traded on Pink Sheets in the United States). Moreover, the Third Circuit decided Georgiou after Porche, and apparently felt no need to criticize, distinguish, or even mention the Second Circuit’s ruling.
Nonetheless, the bright-line rule that Georgiou arguably establishes—namely, that Section 10(b) applies in all cases involving a domestic transaction—currently makes the Third Circuit a more attractive destination for plaintiffs’ counsel in foreign-issuer cases, particularly in cases where other territorial factors might weigh against invoking jurisdiction. For this reason, I expect to see more cases of this kind filed in district courts in the Third Circuit in the future.