United States: Securities Law/Commodities Exchange Act (CEA) - The World In U.S. Courts: Summer-Fall 2018

Last Updated: December 6 2018
Article by   Orrick

Focus of Inquiry in Determining Whether Cross-Border Transaction Is Subject to US Securities Laws Should Be Formation of the Agreement To Buy Shares

Giunta v. Dingman, US Court of Appeals for the Second Circuit, June 19, 2018

As relevant here, plaintiff Erik Gordon sued Dingman in New York, alleging that Dingman violated US securities laws in connection with his sale of shares in his purported holding company, OWH, which supposedly operated restaurants in the Bahamas. Dingman allegedly made various material misrepresentations about the transaction in New York. At issue was whether the transaction should be considered US "domestic," and thus within the scope of the US laws.

The Court of Appeals observed that the US securities laws generally have no extraterritorial application, and thus reach cross-border transactions only where securities are listed on a US exchange or the transaction can be characterized as "domestic." The latter condition exists for transactions in securities in which "(1) irrevocable liability is incurred in the US, or (2) title passes within the US." The shares of OWH are not publicly traded, so the question is whether the sale was a "domestic" transaction.

The Court of Appeals stated that "irrevocable liability" for a transaction could refer either to the seller's obligation to convey or the buyer's obligation to pay, and that both occurred in this instance in the US. The key allegation was that an oral contract was entered into between the parties while in New York. Dingman argued that the agreement did not establish "irrevocable" liability because it was subject to approval by Bahamian regulators. The Court of Appeals rejected this argument, concluding that the irrevocability of the agreement as to the parties was controlling, and that the existence of other conditions that might undo the deal did not change the character of the transaction.

The Court of Appeals also found inapplicable the principle established by the Parkcentral case, in which "the facts may be so predominantly foreign as to render the application of section 10(b) impermissibly extraterritorial" even though the elements of a "domestic" transaction might otherwise be present. Dingman argued that was the case here, because he is a permanent resident of the Bahamas, the venture involved development and operation of businesses in the Bahamas, the corporate entities were all Bahamian, relevant evidence was in the Bahamas, and Bahamian regulations would ultimately control whether the deal would have gone through. The Court of Appeals disagreed, noting that substantial US contacts existed to prevent the transaction being characterized as essentially Bahamian, and indeed almost all the facts relating to the formation of the agreement—the relevant transaction for purposes of the extraterritoriality analysis—occurred in New York.

The Court of Appeals thus reversed a contrary decision by the District Court and returned the case to proceed to trial.

Personal Jurisdiction Over Non-US Executives Upheld Where They Each Signed US Securities Law Filings

In re Veon Ltd. Securities Litigation, US District Court for the Southern District of New York, August 30, 2018

This putative class action under the US securities laws was brought against Veon and four of its senior executives for their alleged roles in Veon having made allegedly false and misleading securities filings. Veon, whose securities were traded in the US, was incorporated in the Bahamas and had its principal place of business in The Netherlands. None of the executives resided in the US. As relevant here, they moved to dismiss the complaint on grounds that the Court could not assert personal jurisdiction over them.

The Court stated that asserting specific personal jurisdiction over a non-US defendant must satisfy the "minimum contacts" test of the Due Process Clause of the US Constitution, and because the securities laws authorize worldwide service of process, the test must focus on the defendant's contacts with the US as a whole, not merely with the forum State. Those contacts, in turn must be "actions by the defendant himself that create a substantial connection with the forum," and must give rise to the claim. The Court found this test satisfied by the plaintiffs' allegations that the defendants were senior executives of a multinational company who signed required SEC filings, meaning that they were targeting the US and understood the filings would be relied upon by US and other investors trading on US exchanges.

Due Process also requires that the assertion of jurisdiction be "reasonable." Where, as here, the "minimum contacts" test has been satisfied, the defendants must make a "compelling case" for the existence of other factors that might make the assertion of jurisdiction unreasonable. The Court noted that the reasonableness requirement is almost always satisfied in cases brought under federal statutes providing for nationwide service of process, as those statutes carry with them an expression of a strong federal interest in the subject matter of the litigation. The defendants could make no such showing, with their arguments about the inconvenience of litigation in the US not rising to the required showing that defending themselves be "gravely difficult."

CEA Applies to Trades Cleared and Settled on Korean Exchange Because their Earlier "Matching" on the Globex Exchange in Illinois Established a Binding US Contract

Myun–uk Choi v. Tower Research Capital LLC, US Court of Appeals for the Second Circuit, May 9, 2018

Plaintiffs, five Korean citizens, bought and sold futures contracts on the "night market" of the Korea Exchange, KRX. Although KRX is headquartered in Korea, orders placed at night are matched with a counterparty on the CME Globex electronic platform in Illinois. Trades so matched are then cleared and settled on the KRX when it opens for business the next day. The plaintiffs sued a New York-based options trader under the CEA, claiming that it had "manipulated" the market and caused the plaintiffs to lose money. The trial court had dismissed the action in part because it considered the case to seek an impermissible extraterritorial application of the CEA to transactions in Korea. The Court of Appeals in New York disagreed with the trial court's characterization of the facts, and vacated its decision.

Prior cases had established that the antifraud provisions of the principal US securities laws applied to (i) "transactions in securities listed on domestic exchanges" and (ii) "domestic transactions in other securities," with the latter term including situations where "irrevocable liability is incurred or title passes within the United States." The Court of Appeals noted that the CEA is worded differently from the antifraud provisions, and accordingly the CEA may not include any test that depended on whether a security was traded on a "domestic exchange." Regardless, jurisdiction would still attach under the CEA if it involved application to a "domestic transaction," and the Court of Appeals thought the complaint made such an allegation "plausible." Specifically, the plaintiffs alleged not only that KRX night market trades bind the parties once they are "matched," but also that the "express view" of the Chicago Mercantile Exchange, which operates CME Globex, is that matches on the electronic platform "are essentially binding contracts" and that exchange members "are required to honor all bids or offers which have not been withdrawn from the market." The Court of Appeals found no basis to conclude that a trading party "may unilaterally revoke acceptance following matching on CME Globex." and thus in the "classic contractual sense" parties incur irrevocable liability on KRX night market trades at the moment of matching. In such case, the transactions would be deemed domestic and the CEA would apply.

Complaint Failed To Establish That Acquisitions of Stock in Swiss Entity and Promissory Note From Swiss National Were Acquired in US "Domestic" Transactions

Schentag v. Nebgen, US District Court for the Southern District of New York, June 21, 2018

Schentag is a holder of medical patents who entered into a business arrangement with Nebgen so he could obtain funding to commercialize his inventions. Schentag's New York company transferred his patents to a Swiss limited partnership, in exchange for which he received an ownership share and a promissory note. Schentag never received payment under the note and he alleged that the transaction was a fraud. He sued Nebgen in New York under the federal securities laws.

As relevant here, the Court noted that the US securities laws have no extraterritorial application, applying only to securities traded on a US exchange or transactions deemed US "domestic." This latter class of transactions was described by the Court as comprising transactions where "irrevocable liability" for a purchase or sale arises or "title passes" in the US. The Court found this test not to have been satisfied by bare allegations that certain meetings that led to the transaction took place in the US. It observed, for example, that the complaint failed to allege that Schentag "came to an agreement with Nebgen about the terms of the transaction" during the US meetings, including that Schentag there agreed to become a shareholder of the Swiss entity or that he would accept a promissory note in exchange for his intellectual property.

The Court also rejected Schentag's argument that the transaction was US "domestic" because his acquisition of and payment for the Swiss shares was paid for by funds wired his New York account, observing that transfers of money, alone, were inadequate to establish the location where a transaction occurred for purposes of the extraterritoriality analysis. For the foregoing reasons, Schentag's claims under the US securities laws were dismissed.

[Editor's Note: The Schentag case is also addressed in the Personal Jurisdiction/Forum non Conveniens section of this report.]

Court of Appeals Finds US Securities Laws Applicable to Trades in ADRs Because They Were Consummated in US

Stoyas v. Toshiba Corp., US Court of Appeals for the Ninth Circuit, July 17, 2018

Purchasers of American Depository Receipts (ADRs) of Toshiba Corporation of Japan lost money when Toshiba restated profits in connection with an accounting fraud. Various purchasers brought a putative class action against Toshiba and its executives in the US under the antifraud provision of the US Securities laws as well as a Japanese counterpart. The trial court dismissed the action as reflecting an impermissibly extraterritorial application of Section 10(b). In this opinion, the court of appeals reinstates the case.

Fraud claims under US securities law generally can proceed only with respect to securities registered on a US "exchange," or where that is not the case if the transaction in question took place in the US. The latter test is satisfied in either of two ways: (i) where "the purchaser incurred irrevocable liability within the US to take and pay for a security or the seller incurred irrevocable liability within the US to deliver a security, "or (ii) where "title" to the security passed from seller to buyer in the US.

The Court of Appeals first concluded that the Toshiba ADRs are "securities." It then expressed skepticism that the particular private market on which the ADRS traded (OTC Link) was an "exchange," but did not resolve the question because the transaction occurred in the US and so satisfied the alternative test for extraterritorial applicability. Specifically, the Court of Appeals noted that both the buyer and the institutions selling the ADRs were based in the US and thus consummation of the transactions must have been US domestic. Another case had declined to apply the securities laws to facts having little connection to the US even where transactions had occurred in the US, but the Court of Appeals did not consider it correctly decided. In any event, the other decision was distinguishable because, unlike the present action, it involved private contracts rather than ADRs, the contracts were traded outside the US and not tied to the value of the stock whose company was affected by fraud, and the defendant company was not alleged to have been aware of the contracts.

All of this said, the Court of Appeals found the complaint inadequate to allege a substantive violation and returned the case to the trial court so that the plaintiffs might seek to cure these defects.

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