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.

The Third Circuit engaged in a searching analysis of plaintiffs’ falsity and scienter allegations and found them insufficient under the exacting standards of the Reform Act, upholding the district court’s dismissal of the complaint in OFI Asset Management v. Cooper Tire & Rubber, — F.3d —, 2016 WL 4434404 (3d Cir. 2016).

In its ruling, the Third Circuit also had some harsh words for plaintiffs’ “kitchen sink” pleading style, finding that it “has been a hindrance at every stage of these proceedings.”  Id. at *7.

The case is tied to Cooper’s failed merger with Apollo Tyres.  Cooper was valuable to Apollo largely due of its manufacturing facility in China (“CCT’), of which it owned 65%, with the remaining 35% owned by a Chinese company.  The merger fell through after workers at CCT went on strike, denied Cooper officials access to the facility, refused to provide Cooper with financial information, and stopped producing Cooper-branded tires.  At the same time, the merger announcement led to a labor dispute in Cooper’s U.S. manufacturing facilities, with a labor arbitrator eventually finding in favor of the union and barring Cooper from selling two of its U.S. plants to Apollo.

Plaintiffs alleged that Cooper made a number of false or misleading statements under Section 10(b) and 14(a) in connection with the failed merger, including in the merger agreement, the proxy statement, its financial statements, and two 8-Ks containing news about the merger.  The claim was dismissed by the district court in Delaware for failure to adequately allege falsity and scienter.

Prior to oral argument, the district court had ordered plaintiffs to submit a letter identifying the five most compelling examples of allegedly false statements, with three factual allegations demonstrating the falsity of each statement and three allegations supporting scienter as to each of the statements.  Upon appeal, plaintiffs’ first objection was as to the court’s process, arguing that the court abused its discretion by considering only five “artificially selected” allegedly false statements, and failing to rule on the whole of plaintiffs’ complaint.

The Third Circuit considered plaintiffs’ “umbrage. . . unfounded.” Far from harming OFI’s case, the court found that the district judge had tried to “give OFI an assist,” by offering it a chance to frame the issues in its complaint more clearly.  Asking OFI to bring some order and clarity to its 100-page, 245-paragraph complaint was well within the district judge’s discretion to manage complex disputes, and does not show that the judge failed to consider the allegations as a whole.  Id. at *6.

Held the Third Circuit: “As pled, the Complaint presents an extraordinary challenge for application of the highly particularized pleading standard demanded by the PSLRA. This is true not only due to the length of the Complaint, but also its lack of clarity. . . . Now that OFI has come to us with the same kind of broad averments that drove the District Court to demand specificity, we find ourselves more than sympathetic to the Court’s position.”  Id. at *6.

After holding that the district court had not abused its discretion in managing the case, the Third Circuit went on to explore in detail each of the allegedly false statements, finding that none of them were sufficient to maintain a claim.  In doing so, the court considered the context of each allegedly false or misleading statement, and examined whether the allegations of falsity as to each were sufficiently specific, rejecting those allegations that lacked the particularity required of the Reform Act or which failed to show how a statement was misleading rather than simply incomplete.

As to a number of forward-looking statements, the Third Circuit held that its allegations of falsity failed to account for the Reform Act’s Safe Harbor.  Because the statements had been accompanied by meaningful cautionary statements, the court held that the Safe Harbor immunized them from liability—and thus they were not actionable even if plaintiffs could show that they were false and made with scienter.  Id. at *15.

In regard to one isolated statement, the court also found that even if OFI had sufficiently pleaded technical falsity, it nevertheless failed to raise a strong inference of scienter, because the “plausible opposing inferences” were more likely, “including that the statement was simply imprecise or received little attention due to the context in which it was made[.]”  Id. at 12.

Wrote the court: “OFI’s post hoc scouring of countless pages of documents for a stray and inartfully phrased comment that can be argued to be technically false seems like just the sort of litigation maneuver the PSLRA was meant to eliminate. One purpose of the statute was to prevent disappointed investors from treating every imprecise statement during a transaction as an invitation to file a lawsuit.”  Id. at *13.