Corporate Governance

From the Pages of The Pomerantz Monitor: Supreme Court Hears F-Cubed Case

By Carolyn Moskowitz

As Jay Dean reports in the March/April issue of The Pomerantz Monitor, on March 29, the U.S. Supreme Court heard arguments on whether U.S. courts have jurisdiction over cases involving international investors purchasing securities traded on exchanges outside the United States. Early press reports of the oral argument suggest that plaintiffs may face an uphill battle. 

The case before the Supreme Court, Morrison v. National Australia Bank, (?NAB?) addressed the issue of ?foreign-cubed? ? or simply ?f-cubed? ? cases, because it involves plaintiffs from outside the United States, suing a firm whose headquarters and main operations are outside the United States, based on losses they incurred on securities exchanges outside the United States.

In recent years, so-called f-cubed lawsuits have become more common, as the global credit crisis led to a rise in claims against foreign banks in U.S. courts. 

 The defendant, National Australia Bank (?NAB?), is Australia?s largest bank. The case arose out of NAB?s purchase in 1998 of an American mortgage service provider, HomeSide Lending, which at the time reported substantial profits. However, these profits were inflated by HomeSide?s fraudulent accounting for its mortgage servicing rights, which were incorporated into NAB?s reported results. In December 2001, NAB belatedly wrote down by $2 billion the value of HomeSide?s mortgage servicing rights, causing NAB?s shares and ADRs to drop more than 11.5%.

The case originated in the Southern District Court, which held that it did not have subject matter jurisdiction over the claims brought by three foreign plaintiffs based on transactions conducted on foreign exchanges. (Claims by a fourth domestic plaintiff were dismissed on grounds that it lacked any losses.)

On appeal, the Second Circuit asked the Securities and Exchange Commission to submit an amicus brief, which argued that the anti-fraud provisions of the federal securities laws should apply to transnational frauds that result exclusively or principally in overseas losses, if conduct in the United States is material to the fraud?s success and forms a ?substantial component? of the fraudulent scheme. Nonetheless, the Second Circuit held that the connection between the losses sustained by the foreign investors and the fraudulent conduct in the United States was too attenuated for U.S. securities laws to apply, since the decision on how and whether to incorporate the misleading HomeSide financials was made in Australia.

In advance of the Supreme Court argument, roughly a dozen amicus briefs were filed by non-parties advocating for one side or the other. These include institutional investors from outside the United States, among them a number of pension funds.

The U.S. government submitted a brief in which it reaffirmed the SEC?s ?substantial component? jurisdictional test, but urged dismissal on grounds that foreign investors could not prove reliance or loss causation where there were no statements issued in the US that directly caused injury to the foreign investors.

At oral argument, Justice Breyer questioned whether a claim could be asserted if the foreign investor could link its investment decision to conduct within the U.S. (which clearly could be the case in an emerging case on behalf of investors against Toyota). Moreover, since recent studies show that stock prices in global markets move in tandem with US markets, it can be argued that securities fraud with a manifest component in the United States has a global impact, and thus should be subject to recovery in the U.S. courts. NAB will be carefully watched.

Full post as published by PomTalk on April 15, 2010 (boomark / email).