The Situation: Since the Supreme Court decided Morrison v. National Australia Bank Ltd. ("Morrison") in 2010 and rejected the Second Circuit's "conduct and effects test," the Second Circuit has grappled with the issue of whether securities and commodities transactions are sufficiently "domestic" for the federal securities and commodities laws to apply.
The Result: On August 29, 2019, the Second Circuit concluded in Prime International Trading, Ltd. v. BP P.L.C. ("Brent Crude") that the Commodity Exchange Act ("CEA") could not be applied to certain derivatives transactions on the New York Mercantile Exchange ("NYMEX") because all of the allegedly manipulative conduct in the underlying spot market occurred abroad.
Looking Ahead: The Second Circuit's focus in Brent Crude on the location of the allegedly manipulative conduct, rather than the location of the allegedly manipulated transaction, is arguably inconsistent with Morrison. While the Supreme Court refused to grant certiorari in a Ninth Circuit case involving the territorial reach of the federal securities laws last year, it may be more inclined to do so now in Brent Crude.
Morrison and its Second Circuit Progeny
In Morrison, the Supreme Court applied the presumption against the extraterritorial application of U.S. law to claims under Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and concluded that such claims could only be applied to: (i) "transactions in securities listed on domestic exchanges"; and (ii) "domestic transactions in other securities." In making this determination, the Court rejected the "conduct and effects" test previously applied by courts in the Second Circuit (which focused on where the alleged misconduct occurred and where its effects were felt), reasoning that "the focus of the Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States."
In Absolute Activist Value Master Fund, Ltd. v. Ficeto (2012) and Loginovskaya v. Batratchenko (2014) ("Loginovskaya"), the Second Circuit established an "irrevocable liability" test for determining whether securities and commodities transactions that were not executed on domestic exchanges were sufficiently "domestic" for U.S. laws to apply under Morrison's second prong. Under this test, the Exchange Act and the CEA could be applied to transactions in which "irrevocable liability is incurred or title passes within the United States." However, just weeks before issuing its decision in Loginovskaya, the Second Circuit effectively created an exception to the general rule that the federal securities laws can be applied to "domestic transactions," holding in Parkcentral Global HUB Ltd. v. Porsche Automobile Holdings SE ("Parkcentral") that some claims "are so predominantly foreign as to be impermissibly extraterritorial." In that case, the Second Circuit relied heavily on the "foreignness of the facts constituting the defendant's alleged violation" in determining that Section 10(b) of the Exchange Act could not be applied.
Since Parkcentral, litigants—and the courts—have struggled with the "predominantly foreign" exception and whether the location of alleged misconduct is relevant to the question of whether the federal securities and commodities laws can be applied to particular transactions. For example, in Choi v. Tower Research Capital LLC (2018) ("Choi"), the Second Circuit did not mention either Parkcentral or the "predominantly foreign" exception in concluding that certain futures transactions that were settled and cleared on a Korean derivatives and securities exchange were nonetheless sufficiently "domestic" for the CEA to apply.
In Brent Crude, the plaintiffs alleged that the defendants engaged in fraudulent transactions in the market for physical Brent crude cargoes, which allegedly resulted in manipulation of the market for Brent crude derivatives traded on NYMEX and Intercontinental Exchange Futures Europe ("ICE Futures Europe"). The district court dismissed the plaintiffs' claims under the CEA on extraterritoriality grounds—primarily relying on Parkcentral—concluding that "while the Trader Plaintiffs may have purchased or sold Brent futures and derivatives on domestic exchanges or otherwise entered into domestic commodities transactions, the crux of their complaints against Defendants does not touch the United States."
The Second Circuit affirmed the district court's dismissal, and in doing so relied heavily on the location of the alleged wrongdoing and the "predominantly foreign" exception it created in Parkcentral. The Second Circuit "assume[d] without deciding that Plaintiffs' trades on NYMEX and ICE Futures Europe constituted 'domestic transactions'" under Section 22 of the CEA, but determined that the plaintiffs' claims were nonetheless impermissibly extraterritorial because "[n]early every link in Plaintiffs' chain of wrongdoing is entirely foreign." The Second Circuit concluded that "[w]ere we to hold otherwise, the CEA would indeed 'rule the world.'"
State of the Law Going Forward
The common thread that seems to explain the Second Circuit's divergent decisions in Brent Crude and Choi is the location of the alleged misconduct. In Choi, the Second Circuit based its extraterritoriality analysis on a straightforward application of the "irrevocable liability" test, and the allegation that the transactions at issue were electronically matched on a platform located in the United States during overnight hours (before being settled and cleared in Korea the following morning). However, applying that same analysis in Brent Crude almost certainly would have resulted in a denial of the defendants' motion to dismiss (at least under the assumption that the derivatives transactions executed on NYMEX in Brent Crude were at least as "domestic" as the transactions that were matched on the U.S.-based platform in Choi). The different results reached in Choi and Brent Crude therefore appear to have been based, at least in part, on the fact that the alleged misconduct at issue in Choi allegedly emanated from a high-frequency trading firm in the United States (although the Second Circuit did not expressly rely on that fact in its extraterritoriality analysis).
The Second Circuit's focus on the location of the alleged misconduct in Brent Crude—and its unstated reliance on that factor in Choi—is arguably inconsistent with the Supreme Court's decision in Morrison, and is certainly inconsistent with the Ninth Circuit's recent decision in Stoyas v. Toshiba Corp. (which expressly rejected Parkcentral's "predominantly foreign" exception). This inconsistency leaves market participants with little guidance on whether securities and commodities transactions with substantial foreign ties may subject them to suits in the United States.
Three Key Takeaways
- The Second Circuit's recent decisions suggest that its extraterritoriality analysis in securities and commodities cases is focused more on the location of the alleged misconduct than the location of the transactions, which seems eerily similar to the "conduct and effects" test that was previously rejected in Morrison.
- Even after the Second Circuit's decision in Brent Crude, there is still considerable uncertainty about how "foreign" a defendant's conduct must be before it qualifies as "predominantly foreign" and therefore outside the reach of the U.S. securities and/or commodities laws under Parkcentral.
- While the Second Circuit rejected the position taken by the U.S. Commodity Futures Trading Commission in an amicus brief that the U.S. commodities laws could and should be applied to the transactions at issue in Brent Crude, the Second Circuit left open the possibility that a different conclusion could have been reached if the transactions had occurred after the Dodd-Frank amendments to the CEA. As a result, market participants should continue to monitor decisions applying Section 2(i) of the CEA, which—according to the Second Circuit—"contains, on its face, a 'clear statement' ... of extraterritorial application."
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