September 3, 2014

Second Circuit Addresses Whether Cross-Border Swaps Fall Within The Territorial Jurisdiction of Federal Securities Laws

Arnold & Porter Advisory

The New York-based U.S. Court of Appeals for the Second Circuit recently issued a significant decision clarifying the application of federal securities laws to cross-border securities transactions.  In Parkcentral Global Hub Ltd. v. Porsche Automobil Holding SE (Porsche), the Second Circuit ruled that plaintiffs cannot necessarily invoke Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act)—the primary provision in the U.S. securities laws for civil anti-fraud claims—just because their lawsuit is based on securities transactions that occurred or were entered into in the United States.1  The Second Circuit took a flexible approach to the invocation of Section 10(b), expressly declining to adopt a bright-line test because of the difficulty any such test would pose “in a world of easy and rapid transnational communication and financial innovation.”2  

Background on Parkcentral Global Hub Ltd. v. Porsche Automobil Holding SE

In the Porsche case, more than thirty international hedge funds sued Porsche, a German corporation, and certain Porsche executives, under Section 10(b) for alleged market manipulations and misrepresentations.  Specifically, the plaintiffs claimed that these defendants “lied about Porsche’s intent to take over” another Germany company, Volkswagen AG (VW), and that these defendants hid the extent of Porsche’s control of VW from the market through “manipulative option trades.”3  According to the operative complaints, the defendants’ concealment of Porsche’s intention to acquire control of VW led the plaintiffs “to conclude erroneously that the demand for VW stock was lower than it actually was.”4  The plaintiffs purportedly entered into securities-based swap agreements in the United States that referenced the price of VW stock and stood to gain value if the price of VW stock declined.  In their Section 10(b) suit, the plaintiffs claimed that they incurred significant trading losses when the price of VW stock increased after Porsche’s acquisition of VW.5  

The defendants moved to dismiss the operative complaints based on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, which had held that Section 10(b) of the Exchange Act does not apply extraterritorially.[[561 U.S. 247 (2010).]]  Under Morrison, Section 10(b) applies only to “transactions listed on domestic exchanges and domestic transactions in other securities.”6  In opposition to the Porsche defendants’ motion to dismiss, the plaintiffs argued that because they entered into the relevant swap agreements in the United States, their transactions qualified as “domestic transactions in other securities” for purposes of Morrison and therefore fell within the ambit of Section 10(b) of the Exchange Act.  The plaintiffs, moreover, asserted that at least some of the allegedly fraudulent statements by Porsche and its executives were made in the United States.

The district court granted the defendants’ motion to dismiss, concluding that the plaintiffs’ securities-based swap agreements, which were based on shares that traded on foreign exchanges, were essentially transactions in foreign securities.  The plaintiffs appealed the dismissal of their suit.  

The Second Circuit’s Ruling

On August 15, 2014, more than two years after oral argument, a Second Circuit panel unanimously affirmed the dismissal of the action—“although for reasons somewhat different from those set forth by the district court.”7  The Second Circuit held that “the imposition of liability under § 10(b) on these foreign defendants with no alleged involvement in plaintiffs’ transactions, on the basis of the defendants’ largely foreign conduct, for losses incurred by the plaintiffs in securities‐based swap agreements based on the price movements of foreign securities would constitute an impermissibly extraterritorial extension of [Section 10(b)].”8  That the plaintiffs had entered securities-based swap agreements in the United States was not dispositive to Morrison’s extraterritoriality inquiry.

The Second Circuit reasoned that while Morrison “unmistakably made a domestic securities transaction (or transaction in a domestically listed security) necessary to a properly domestic invocation of § 10(b), such a transaction is not alone sufficient to state a properly domestic claim under the statute.”9  The Court noted its concern that “a rule making the statute applicable whenever the plaintiff’s suit is predicated on a domestic transaction, regardless of the foreignness of the facts constituting the defendant’s alleged violation, would seriously undermine Morrison’s insistence that Section 10(b) has no extraterritorial application” and place Section10(b) “in conflict with the regulatory laws of other nations.” 

However, the Second Circuit cautioned that “[w]e do not purport to proffer a test that will reliably determine when a particular invocation of § 10(b) will be deemed appropriately domestic or impermissibly extraterritorial.”10  The Court emphasized that its decision in the Porsche case turned on the particular character of the securities-based swap agreements at issue, which were tied to securities that trade exclusively in foreign markets.  The Court further explained that “[i]n a world of easy and rapid transnational communication and financial innovation, transactions in novel financial instruments—which market participants can freely invent to serve the market’s needs of the moment—can come in innumerable forms of which we are unaware and which we cannot possibly foresee.”11 

“Out of an abundance of caution,” the Second Circuit remanded to the district court for consideration of any motions by the plaintiffs to amend their complaints in response to this appellate decision.12  


The Porsche case illustrates the difficulty that lower courts have faced in applying Morrison to cross-border transactions that cannot be easily classified as “domestic” or “foreign.”  In what may end up being a highly influential decision, the Second Circuit has shied away from a reading of Morrison that would allow jurisdiction over any securities transaction that occurs in the United States.  The Court instead embraced a much more flexible—though somewhat amorphous—approach that uses Morrison’s focus on the location of a securities transaction as the first, but not the final, step in an extraterritoriality inquiry.

The Second Circuit now requires more than just a “domestic” transaction to invoke Section 10(b) of the Exchange Act.  Factors such as the identity of the parties and the location of the alleged misconduct may be relevant.  In many respects, the Second Circuit’s consideration of a variety of factors resembles the forum non conveniens  analysis that courts use to decide whether another forum is more appropriate for the resolution of a dispute.

While the Porsche case provides defendants with ammunition to seek the dismissal of a Section 10(b) claim involving cross-border securities transactions, plaintiffs (and their lawyers) may be undeterred.  So long as the United States offers comparatively liberal discovery rules and the prospect of large jury awards, U.S. courts will have to continue grappling with the territorial limits of federal securities laws.  And as the Second Circuit has acknowledged, this is no simple task in an age of international capital markets that rely on electronic communication.

  1. Parkcentral Global Hub Ltd. v. Porsche Automobil Holding SE, Case No. 11-403 (2d Cir. Aug. 15, 2014) (Porsche).

  2. Id., Slip Op. at 46.

  3. Id. at 22-23.

  4. Id. at 11.

  5. According to Second Circuit, securities-based swaps are “synthetic investments” that are “essentially wagers on changes in the price of the reference securities,” and the plaintiffs’ investments were “economically equivalent to short sales referencing VW shares.” Id. at 11, 18.

  6. Id.  Morrison rejected the so-called “conducts” and “effects” test that the Second Circuit had been applying.

  7. Porsche, Slip Op. at 2.

  8. Id. at 47-48.

  9. Id. at 40.

  10. Id. at 46.

  11. Id.

  12. Id. at 7.

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