Sunday, November 2, 2008
The Second Circuit recently re-examined subject matter jurisdiction over Rule 10b-5 actions in In re National Australia Bank Ltd (2d Cir. Oct. 23, 2008). In what the court described as a "foreign-cubed action," foreign plaintiffs sued a foreign issuer in federal district court alleging Rule 10b-5 violations based on securities transactions in foreign countries. Specifically, plaintiffs (purchasers of National Australia Bank (NAB) stock on foreign exchanges) alleged that HomeSide Lending, a Florida-based mortgage service provider and wholly-owned subsidiary of NAB, engaged in accounting fraud that inflated NAB's stock price. In affirming the lower court's dismissal of foreign plaintiffs' claims for lack of subject matter jurisdiction, the Second Circuit referred to the "conduct" and "effects" tests previously developed by the Second Circuit: (1) whether the wrongful conduct occurred in the U.S. and (2) whether the wrongful conduct had a substantial effect in the U.S. or upon U.S. citizens. In this case, however, plaintiffs relied solely on the conduct test.
Under the conduct test, the critical distinction is whether the defendant's activities in the U.S. were "more than merely preparatory" to the allegd fraud and "directly caused" losses to investors abroad. This involves a comparison of how much of the fraud was done in the U.S. and how much was done abroad. In this case, Homeside allegedly manipulated its books and records in Florida and sent the inflated numbers to NAB in Australia. NAB, in turn, created and distributed its public filings from its headquarters in Australia.
The Second Circuit rejected the adoption of a "bright-line" test urged by defendants and some of the amicus curiae filed in this case (including the U.S. Chamber of Commerce) that domestic conduct alone would never be enough to find subject matter jurisdiction. It minimized the argument that the current tests created potential conflict between U.S. and foreign antifraud laws, noting that "anti-fraud enforcement objectives are broadly similar." Moreover, the Court reiterated the importance of the goal of "preventing the export of fraud from America." The court, however, rejected the SEC's position as amicus curiae and found that HomeSide's manipulation of the numbers in Florida was less central to the fraud than NAB's actions in Australia. It emphasized that NAB's responsibilities include preparation and dissemination of the financial statements and other statements to the investing public. In addition, the court relied on the absence of any allegations that U.S. investors or U.S. financial markets were harms and what it saw as the "lengthy chain of causation" between the Florida manipulation of numbers and the harm to investors -- NAB had numerous opportunities to detect and correct the improper numbers.
Finally, the Court observes that:
(1) The D.C. circuit has misconstrued the Second Circuit test as requiring the domestic conduct to comprise all elements necessary to establish a Rule 10b-5 violation, and
(2) It would help the courts if Congress and the SEC address the appropriate scope of the statute to overseas transactions.