In Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869 (2010), the Supreme Court held that Section 10(b) and Rule 10b-5 of the Exchange Act only applies to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.” While the Court, in that case, was able to analyze the facts under the first test, regarding securities listed on domestic exchanges, it did not address the second test, and it remained significantly ambiguous what constituted a “domestic transaction in other securities,” after Morrison.
Therefore, it came as a relief to get additional guidance about this second test from the Second Circuit in the recent case of Absolute Activist ValueMaster Fund Ltd. v. Ficeto, decided on March 1, 2012. In that case the plaintiffs were nine Cayman Island hedge funds who sued the defendant, their investment manager, Absolute Capital Management Holdings Limited, and several of its officers and employees (several of whom were not U.S. citizens nor located in the U.S.), basically alleging a pump and dump scheme resulting in losses of over $195 million. The plaintiffs purchased securities issued by U.S. companies however, and the deals were brokered through a U.S. broker dealer.
The case came before the Second Circuit who considered the issue of whether the allegations in the complaint were sufficient to allege a “domestic transaction in other securities,” to survive scrutiny under Federal Rule of Civil Procedure 12(b)(6). When considering these allegations the court provided very helpful guidance in determining what factors are, and are not, relevant in passing this test to see if Section 10(b) and Rule 10b-5 are applicable to the transactions.
The Second Circuit held that to sufficiently allege the existence of a “domestic transaction in other securities” the plaintiff must allege facts leading to the plausible inference that either irrevocable liability was incurred or title transferred within the United States. The court explained that the parties “incur irrevocable liability” basically when the contract is formed between the parties. The point of irrevocable liability can be used to determine the locus of a securities purchase or sale. Facts that can be alleged which make this plausible inference could include, but are not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money.
The Second Circuit was also clear about what types of allegations would not be sufficient to constitute a domestic transaction in other securities. For example, the conclusory allegation that the transaction took place in the United States is insufficient. Further, the focus should be upon the locus of the purchases and sales of the securities, and not on the place where the alleged deception originated which constituted the securities fraud. Therefore, in making allegations, although these things may be relevant, they will not be conclusory: the identity of the parties, the type of security at issue, or whether each individual defendant engaged in conduct with in the United States.
The additional clarification by the Second Circuit in Ficeto will be of great help to securities attorneys who represent clients who have purchased or sold securities which are not listed on domestic exchanges. In such instances focusing on the locus of where the contract was formed, or title passed, can help determine whether the Exchange Act applies to the transaction, or not.