Originally published January 25, 2011

Keywords: Morrison, securities claims, Porsche, purchase, swap agreements

The US Supreme Court's decision in Morrison v. National Australia Bank foreclosing the extraterritorial application of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) has scuttled another fraud complaint. On December 30, 2010, Judge Harold Baer Jr. of the Southern District of New York dismissed Section 10(b) and Rule 10b-5 claims brought by a group of global hedge funds against German car manufacturer, Porsche Automobile Holding SE (Porsche) and two of its executives—Wendelin Wiedeking, CEO and Holger Haerter, Vice President of Finance—based on the Supreme Court's decision in Morrison.1

In Morrison, the Supreme Court held that Section 10(b) applies only to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities." Applying the Supreme Court's "transactional test," Judge Baer concluded that plaintiffs' securities-based swap agreements did not trigger extraterritorial application of the antifraud provisions of the Exchange Act because the "economic reality is that the swap agreements are essentially 'transactions conducted upon foreign exchanges and markets,' and not 'domestic transactions' that merit the protection of Section 10(b)." Elliott Associates LP v. Porsche Automobile Holding SE, 1:10-cv-00532 (S.D.N.Y. Dec. 30, 2010).

In total, six actions were dismissed by Judge Baer. In the first action, plaintiffs consisted of 35 hedge funds, 18 of which were organized under the laws of foreign jurisdictions. In the second action, which was filed a few months after the first action and involved substantially the same allegations, plaintiffs consisted of 4 hedge funds, each of which was organized under the laws of the Cayman Islands. Judge Baer consolidated these actions on June 22, 2010. Just before the motions to dismiss were fully briefed, four related actions were filed against Porsche, Wiedeking and Haerter. All parties agreed that Judge Baer's decision in the first two joined actions would govern the related lawsuits as well. As a result, the complaints in the four related actions were similarly dismissed.

In Elliot Associates, the plaintiffs alleged that they entered into security-based swap agreements that referenced the share price of another German car company, Volkswagen (VW). The swap agreements generated gains for plaintiffs as the price of VW shares declined and generated losses as the price of VW shares rose. According to the plaintiffs, defendants caused a dramatic rise in the price of VW stock by buying nearly all the freely traded voting shares of VW as part of a secret plan to take over VW.

The plaintiffs alleged that Porsche secretly intended to acquire 75 percent ownership of VW, while making false and misleading statements about its intentions and ability to purchase such a large stake in VW, as well as its existing ownership of the company. When Porsche eventually revealed the extent of its VW holdings toward the end of October 2008, the share price significantly increased and caused the plaintiffs to get caught in a "short squeeze," in which they allegedly suffered $2 billion in losses.

Because the swap agreements were not listed on any US exchange, the district court found that the threshold issue was whether they constituted "domestic transactions in other securities." In an effort to convince the court that the swap agreements were domestic transactions, the plaintiffs argued that, not only did US-based investment managers make the investment decisions, but also that all the steps necessary to transact the swap agreements were carried out in the United States, including the signing of swap confirmations.

The court rejected such a narrow interpretation of Morrison's transactional test because it would "extend extraterritorial application of the Exchange Act's antifraud provisions to virtually any situation in which one party to a swap agreement is located in the United States." Judge Baer also noted several decisions within the Southern District that have rejected the notion that "domestic transactions in other securities" include an investor's placement of a buy order in the United States for a security traded aboard. The question, therefore, was whether there is any meaningful distinction between a domestic "buy order" for securities traded abroad and one party's execution in the United States of a swap agreement that references foreign securities.

Judge Baer found that, because "the economic value of securities-based swap agreements is intrinsically tied to the value of the reference security, the nature of the reference security must play a role in determining whether a transnational swap agreement may be afforded the protection of Section 10(b)." Here, the parties agreed that plaintiffs' swap agreements were economically equivalent to the purchases of VW shares on a German exchange. The district court concluded, therefore, that the swap agreements were essentially "transactions conducted upon foreign exchanges," and not "domestic transactions," that foreclosed extraterritorial application of US securities laws under Morrison.

In so holding, the court determined that a "domestic transaction in other securities" to mean "purchases and sales of securities explicitly solicited by the issuer in the United States" and not transactions in foreign-traded securities where only one purchaser is located in the United States.

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1. For a discussion of the Morrison decision as well decisions related to Morrison, please see our Legal Update, "SEC Expands Investigative Reach Under New Extraterritorial Jurisdiction Provisions of the Dodd-Frank Act" and "Second Circuit Clarifies Holding on Extraterritorial Application of RICO Claims".

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