Second Circuit Affirms Dismissal of Securities Fraud Claims

In March 2021, the Second Circuit Court of Appeals clarified its application of Morrison v. National Australia Bank Ltd., a 2010 Supreme Court case that limited the application of Section 10(b) of the Securities Exchange Act to “transactions in securities listed on domestic exchanges” and “domestic transactions in other securities.” The Second Circuit decided two cases that affirmed the dismissal of securities fraud claims for failure to plead a sufficiently domestic securities transaction. However, the court’s differing rationales in reaching similar conclusions could prove instructive as to what the court will consider in its assessment of whether a securities transaction is sufficiently domestic to establish jurisdiction under the Securities Exchange Act.

Securities Exchange Act Only Applies to Domestic Transactions

In Cavello Bay Reinsurance Ltd. v. Shubin Stein (“Cavello Bay”) and Banco Safra S.A.-Cayman Islands Branch v. Samarco Mineracao S.A. (“Banco Safra”), the Second Circuit applied the Supreme Court’s rationale in Morrison to find that Section 10(b) of the Securities Exchange Act could not be applied to reach foreign securities transactions.

Taken together, the decisions indicate that the Second Circuit will carefully scrutinize the extent to which a transaction occurs outside of the United States when deciding whether the Securities Exchange Act applies.

In Cavello Bay, the court assumed the transaction in question was a domestic one under Morrison, but found that the Securities Exchange Act did not extend to a private transaction between a Bermuda corporation with its principal place of business in New York and a Bermuda-based buyer because the transaction was “primarily foreign.”

Yet in Banco Safra, the court found that the plaintiff’s allegations were insufficient to establish that liability occurred within the United States in a transaction that occurred between a Brazilian mining company and a Brazilian bank branch located in the Cayman Islands.

The decisions relied on the Second Circuit’s decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, which held that "to sufficiently allege a domestic securities transaction in securities not listed on a domestic exchange...a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.” The court also relied on Parkcentral Global Hub Ltd. v. Porsche Auto. Holdings SE, where it held that pleading a domestic transaction was a threshold requirement for Section 10(b) to apply.

Cavello Bay Transactions Were “Predominantly Foreign”

In Cavello Bay, the defendant was the CEO of a Bermuda holding company with its principal place of business in New York. In 2015, the business pitched a private offering to an investor firm that was a subsidiary of a Bermuda insurance group and whose principal place of business was Bermuda. The pitch was made by telephone from New York and included a PowerPoint presentation that was sent from New York to Bermuda.

The parties agreed to the investment, and one party signed the agreement in New York, while the other signed in Bermuda. The agreement was then mailed to Bermuda and title to the shares was transferred at a closing that occurred in Bermuda.

Later, Cavello Bay alleged that the defendants violated Section 10(b) of the Securities Exchange Act, claiming that the PowerPoint presentation misrepresented the fee agreement.

The trial court dismissed the case, finding that the transaction was “impermissibly extraterritorial” because: (1) the plaintiff failed to allege a domestic transaction as required under Morrison; and (2) the claims were “so predominantly foreign” that they were impermissibly extraterritorial under Parkcentral.

On appeal, the Second Circuit affirmed the dismissal, but only on the basis that the transaction was “so predominantly foreign” that Section 10(b) of the Securities Exchange Act did not apply. In reaching its decision, the Second Circuit reasoned that the “domestic transaction” requirement was a threshold inquiry and could be underinclusive. As a result, the court found that it needed to analyze the surrounding circumstances of the transaction to determine whether it was predominantly foreign.

The court found that the handful of contacts with the United States were insufficient to provide a nexus with the United States and, as such, the plaintiff’s claims were predominantly foreign and therefore impermissibly extraterritorial under Morrison.

Plaintiff in Banco Safra Failed to Allege a Domestic Transaction

In Banco Safra, a Cayman Islands branch of a Brazil-based bank purchased debt securities issued by a Brazilian mining company. The bonds were initially offered only outside of the United States (though the plaintiff alleged it purchased some of the bonds from a broker-dealer in the United States). The value of the bonds dropped after one of the mining company’s dams in Brazil collapsed, causing deaths, injuries, and property and environmental damage. The plaintiff filed suit in the Southern District of New York, claiming that the defendant made material misstatements and omissions regarding the safety of its mining operations.

The trial court dismissed the claim, finding that the complaint failed to show that “irrevocable liability was incurred with the United States.”

On appeal, the Second Circuit affirmed the dismissal, finding that the plaintiff failed to allege a domestic transaction as required under Section 10(b) of the Securities Exchange Act.

Implications of Cavello Bay and Banco Safra

The decisions are significant for their implications on the applicability of the Securities Exchange Act to foreign transactions and the factors the Second Circuit will consider when determining whether it can exercise jurisdiction.

First, the Second Circuit’s continued reliance on Parkcentral indicates a growing circuit split, as the First and Ninth Circuits have criticized the Second Circuit’s decision in Parkcentral as “open-ended [and] under-defined.” See, e.g., Stoyas v. Toshiba Corp. (9th Circ. 2018).

Second, the decision in Cavello Bay is instructive for its clarification of the nature and extent of the contacts that the court will consider in deciding whether a transaction is “predominantly foreign.”

Finally, the differing rationales between the two cases provide insight into what the court will consider to be a “domestic transaction” for purposes of establishing jurisdiction and the extent to which it will scrutinize the pleadings as a threshold inquiry.

These decisions could have implications on whether a court can exercise jurisdiction in criminal cases that involve foreign securities transactions.

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