No Bright-line Test for "Foreign-Cubed" Securities Fraud Actions

Cases continue to arise involving efforts by foreign shareholders seeking recourse for fraud and mismanagement in US courts.  The efforts reflect the relative ease in suing in the US compared with other jurisdictions.

In Morrison v. Nat'l Austl. Bank Ltd. three Australian investors (“Plaintiffs”) sued National Australia Bank, and its wholly owned United States based subsidiary, HomeSide, alleging violations of Sections 10(b) and 20(a) and Rule 10b-5.  The case was an example of a"foreign-cubed” securities fraud action, a suit invovling foreign plaintiffs, foreign defendants, and invovling securities transactions taking place entirely in foreign jurisdictions.

The Second Circuit Court of Appeals dismissed the claim for lack of subject matter jurisdiction because the majority of the alleged fraud took place in Australia, not the United States.  Nonetheless, in dismissing the claim, the court did not articulate a categorical rule but reaffirmed the use of a case by case, fact dependant analysis to determine subject matter jurisdiction for "foreign-cubed” securities fraud actions. Morrison v. Nat'l Austl. Bank Ltd., No. 07-0583-cv, 2008 U.S. App. LEXIS 21986, (2d Cir. 2008).

National Australia Bank (“NAB”) is incorporated and headquartered in Australia.  In 1998, NAB acquired HomeSide Lending Inc., an American mortgage service provider headquartered in Florida.  In 2001, NAB announced write-downs to correct overstated corporate assets.  NAB’s stock price plummeted in response.  Plaintiffs alleged that NAB, HomeSide, and various directors and officers (“Defendants”) knowingly mislead investors by using unreasonably optimistic values for corporate assets in its reports to the SEC and general public. Plaintiffs also alleged that this misrepresentation occurred when HomeSide falsified the valuations in Florida and then sent the data to NAB in Australia, where NAB made the information public.

Defendants argued that the governing securities laws were applicable only for conduct within the United States, not the world at large, and therefore, the court was precluded from exercising jurisdiction over such cases. Defendants, and amicus curiae, argued for a simple bright-line test to determine subject matter jurisdiction in “foreign-cubed” cases. They argued that if the class action suit is predominately foreign, subject matter jurisdiction should not be extended. The court disagreed and instead applied the “binary inquiry” test, the traditional test applied whenever the court considers the application of the US securities laws to international transactions.

This “binary inquiry” test first looks to whether the wrongful conduct occurred in the United States and second to whether the conduct had a substantial effect in the United States or on United States citizens. For subject matter jurisdiction to exist under the first part, the alleged conduct has to be more than merely preparatory and directly cause losses.

HomeSide created and sent the allegedly fraudulent accounting data to NAB in Australia. Plaintiffs argued that because the defendants created the “numbers at issue” in Florida, the fraud occurred primarily in Florida. The Second Circuit disagreed.  Citing precedent, the court observed that liability under 10b-5 arose from making false and misleading statements, not from aiding and abetting such statements. The court found that while HomeSide used unreasonably optimistic assumptions, and thus inflated its book value, this was, at most, aiding and abetting the fraud that “culminated abroad.”

The court found that NAB, as the corporation that owned and controlled HomeSide, had the duty to oversee its subsidiaries and ensure the accuracy of reports it issued.  NAB, therefore, was directly responsible for the wrongful conduct. Since it was NAB in Australia that committed the wrongful conduct, and not HomeSide in the United States, the first prong of the “binary inquiry” test failed and the court found that is did not have subject matter jurisdiction.

The Defendants did not get the bright-line test they argued for, but they received the ruling they wanted. The courts, at least in the Second Circuit, will continue to use a case by case test. The onus for assuring accuracy is primarily on those responsible for issuing reports to shareholders and making SEC filings, not those who compile the reports.

The primary materials for this post are available on the DU Corporate Governance Website.