living in a post-morrison world: nappa working group

By the NAPPA Morrison Working Group June 2012

Living in a Post-Morrison World:How to Protect Your Assets Against Securities Fraud

INTRODUCTION ...................................................................................................................................................................1

SECTION 1: The Landscape in the United States Post-Morrison ......................................................................................2

Legal Landscape .........................................................................................................................................................................2

Ways To Buy “International” Stocks On U.S Exchanges: American Depositary Receipts (ADRs) ................................4

So You Bought Your International Stock Overseas – Now What? Alternatives to Section 10(b) claims ......................8

SECTION 2: Finding and Tracking Foreign Litigation and Recovery Opportunities.................................................. 17

1. Do-it-Yourself Monitoring .............................................................................................................................................. 18

2. Class Action Settlement Monitoring/Filing Services .................................................................................................. 18

3. Using a U.S. Law Firm to Monitor and Supervise Foreign Litigation ....................................................................... 19

SECTION 3: The Legal Landscape in Ten Foreign Jurisdictions .................................................................................... 20

AUSTRALIA ........................................................................................................................................................................... 20

BELGIUM ............................................................................................................................................................................... 24

CANADA ................................................................................................................................................................................ 27

DENMARK ............................................................................................................................................................................. 32

FRANCE .................................................................................................................................................................................. 34

GERMANY ............................................................................................................................................................................. 36

JAPAN ...................................................................................................................................................................................... 43

THE NETHERLANDS .......................................................................................................................................................... 46

SOUTH KOREA ..................................................................................................................................................................... 49

UNITED KINGDOM ............................................................................................................................................................ 54

APPENDIX A ........................................................................................................................................................................ 57

APPENDIX B ......................................................................................................................................................................... 62

APPENDIX C ......................................................................................................................................................................... 63

Table of Contents

The contributing members of the group are:

Jonathan Beemer, Entwistle & Capucci, LLP

Stanley Bernstein, Bernstein Liebhard LLP

Peter Borkin, Hagens Berman Sobol Shapiro, LLP

Darren Check, Kessler Topaz Meltzer & Check, LLP

Stephen H. Cypen, Esq., Cypen & Cypen

Jonathan Davidson, Kessler Topaz Meltzer & Check, LLP

Andrew Entwistle, Entwistle & Capucci, LLP

Barbara Hart, Lowey Dannenberg Cohen & Hart P.C.

Michael D. Herrera, Senior Staff Counsel, Los Angeles County Employees Retirement Assn.

Reed Kathrein, Hagens Berman Sobol Shapiro, LLP

Joy A. Kruse, Lieff, Cabraser, Heimann & Bernstein, LLP

Nicole Lavallee, Berman Devalerio

Jonathan K. Levine, Girard Gibbs, LLP

James E. McGovern, Spector Roseman Kodroff & Willis, PC

Kimberly K. Riccardi, Staff Attorney, Colorado PERA

Maya Saxena, Saxena White, P.A.

Daniel S. Sommers, Cohen Milstein Sellers & Toll PLLC

Michael Stocker, Labaton Sucharow LLP

Robert Valer, General Counsel, Alaska Permanent Fund

James Weir, Bernstein Liebhard LLP

Mark Willis, Spector Roseman Kodroff & Willis, PC

The landscape of United States securities laws has drastically changed with the recent Supreme Court case, Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). Due to Morrison, investors no longer have the protection of the U.S. securities laws if the securities were purchased on a foreign exchange. As a result of this landmark decision, we are in a world of unknowns as to how to continue to satisfy our fiduciary duty by recovering damages for securities fraud committed by corporations, the securities of which were purchased on a foreign exchange. In many cases, the fraud is occurring here in the United States and investors now have no recourse under U.S. securities laws.

A NAPPA working group was created by Greg Smith, the President of NAPPA, which was designed to provide a product that can be useful to the NAPPA membership as we navigate these unchartered waters. Although there are efforts underway to hopefully restore the Conduct and Effects tests through working with the Securities and Exchange Commission (SEC) and Congress, this working group has operated under the assumption that the law is now the “transactional” test as set forth in the Morrison decision. This paper has the following three major sections:

1. The Landscape in the United States Post-Morrison

2. Finding and Tracking Foreign Litigation and Recovery Opportunities

3. The Legal Landscape in Ten Foreign Jurisdictions

Greg Smith named as co-chairs of this working group, Catherine LaMarr, General Counsel, Office of the State Treasurer in Connecticut, and Adam Franklin, Senior Staff Attorney, Colorado PERA. Catherine and Adam would like to thank each member of this working group for their efforts over the last several months. It has been nothing short of extraordinary as these individuals spent many hours compiling this very valuable information.

Introduction

Section 1: The Landscape in the United States Post-Morrison

2 Living in a Post-Morrison World: How to Protect Your Assets Against Securities Fraud

Legal LandscapeThe Supreme Court’s 2010 ruling in Morrison upended almost 50 years of precedent, exposing the foreign investments of U.S. institutional investors to new and unfamiliar risks.1 Prior to Morrison, purchasers of foreign securities could often seek remedies in the U. S., availing themselves of the anti-fraud provisions of the U.S. securities laws. Today, many find themselves locked out of U.S. courthouses and stripped of legal protections that were once considered fundamental and sound. More importantly, the Court’s decision, which was intended to provide “clarity, simplicity, certainty, and consistency,”2 has resulted in confusion, complexity, ambiguity, and disarray.

Since the early 1960s, two independent tests guided the extraterritorial application of the U.S. securities laws. The “Conduct Test” permitted the application of U.S. securities laws to foreign companies if the wrongful conduct at issue occurred within the United States;3 while the “Effects Test” examined whether the wrongful conduct had a substantial effect on U.S. markets or citizens.4 The tests rarely operated in isolation, though, providing courts with considerable discretion when weighing the merits of a particular claim. Such flexibility earned the tests criticism for being “vague” and “not easy to administer,”5 but also allowed courts to venture into strange new territories. Complex actions became common, such as “F-Squared” cases, which involve a U.S. investor’s purchase of foreign securities listed on a foreign exchange; or “F-Cubed” cases, which involve a foreign investor’s purchase of foreign securities listed on a foreign exchange.

In 2010, the Supreme Court decided to uproot the Conduct and Effects tests and replace them with a new “Transactional Test,” which sought to respect international comity and tame the widespread application of U.S. securities laws to companies or transactions with little connection to either U.S. markets or U.S. investors.6 Specifically, the Court determined 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. Section 10(b) does not punish deceptive conduct, but only deceptive conduct ‘in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.”7 As a result, the Conduct and Effects tests were inappropriate for determining when extraterritorial jurisdiction should apply. Instead, proper analysis requires examination of the transaction involved, since it is the subject of the

1 Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869 (2010).2 Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620, 624 (S.D.N.Y. 2010).3 See id. at 623. 4 See id.5 Morrison, 130 S.Ct. at 2879.6 See id. at 2884.7 Id. (quoting 15 U.S.C. § 78j(b)).

regulation.8 The Court concluded that it is “only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies.”9

The effects of the Supreme Court’s decision were immediate and jarring. Courts have responded to Morrison with a frenetic mix of rigidity and carelessness, demonstrating little understanding of the Transactional Test and even less understanding of how it should be applied. The result is a state of confusion that appears to both ignore Morrison’s plain language while resolutely adhering to the Court’s perceived policy goals.

While the post-Morrison world is full of uncertainty and confusion, one thing is clear: U.S. institutional investors now face significant risks when investing abroad. Confronting this new reality will require investors to develop robust solutions that protect their assets in light of the jurisdictional limitations imposed by Morrison’s Transactional Test. These solutions may range from a re-examination of international investment strategies to diverse litigation alternatives such as foreign law remedies, state court cases, and new causes of action.

�What�qualifies�as�“transactions�in�securities�listed�on�domestic�exchanges?”District court decisions since Morrison have offered some guidance regarding what constitutes a security listed on a domestic exchange.

Most courts have chosen to apply the Transactional Test broadly, swatting away attempts to circumvent Morrison and exhibiting a general distaste for cases with foreign elements. For example, in September 2010, the U.S. District Court for the Southern District of New York rejected the efforts of U.S. investors to find a loophole in the Transactional Test in In re Alstom SA Securities Litigation.10 The In re Alstom plaintiffs argued that the court should apply U.S. securities laws to the foreign shares they purchased abroad, because the defendant sold American Depositary Receipts (ADRs) on the New York Stock Exchange (NYSE), which were “securities listed on domestic exchange.” The court, however, rejected the argument and held that Morrison required it to focus only on the securities at issue without regard for related securities that were available. In particular, the court found that the plaintiffs’ argument relied on an overly technical reading of Morrison, explaining that “[t]hough isolated clauses of the opinion may be read as requiring only that a security be ‘listed’ on a domestic exchange for its purchase anywhere in the world to be cognizable under the federal securities laws, those excerpts read in total context compel the opposite result.”11 In short, the court had little interest 8 See id.9 Id.10 See In re Alstom SA Securities Litigation, 741 F. Supp. 2d 469, 472 (S.D.N.Y. 2010).

11 Id. at 472.


Living in a Post-Morrison World: How to Protect Your Assets Against Securities Fraud 3

in entertaining interpretations of Morrison that might have the effect of bending the rules of the Transactional Test.12

As to the question of what constitutes a domestic exchange under the Exchange Act, the Morrison decision indicates that the Supreme Court envisioned a broad reading of the Act that includes both traditional, formal securities exchanges and “over-the-counter markets,” both of which are “affected with national public interest.”13 However, some courts have limited the scope of Section 10(b) when the securities at issue are ADRs whose value is tied to ordinary shares traded abroad and when those ADRs are traded only over-the-counter (OTC), making it less likely that U.S. investors were exposed to them.14

What�are�“domestic�transactions�in�other�securities?”The majority’s holding in Morrison makes clear that mere harm to U.S. investors is insufficient to bring a transaction within the scope of the Exchange Act; rather, remedy for such harm is only available if the investors’ purchases or sales took place in the U.S.15 However, the Supreme Court provided no guidance as to how to determine if a purchase or sale was made in the U.S.

Courts have largely rejected attempts by investors to use this prong of the Morrison analysis to expand the decision’s limitations on the reach of the Exchange Act. For example, courts have held that the U.S. citizenship of an investor, the location of an investor, the locus of a trade order, or the fact that an investor suffered injury in the U.S. does not necessarily bring transactions involving foreign securities within the purview of the Exchange Act.16

12 See also In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512, 531 (S.D.N.Y. 2011) (finding “no indication that the Morrison majority read Section 10(b) as applying to securities that may be cross-listed on domestic and foreign exchanges . . . where the purchase and sale does not arise from the domestic listing”); Cornwell, 729 F. Supp. 2d at 623-24 (holding that Section 10(b) does not extend to foreign securities traded on foreign exchanges even if the foreign issuer had American Depositary Receipts (ADRs) listed on U.S. exchanges).

13 Morrison, 130 S. Ct. at 2882 (citation omitted).14 In re Sociéte Générale. Sec. Litig., No. 08 Civ. 2495, 2010 WL 3910286, at *6 (Sept. 29,

2010).315 See Morrison, 130 S. Ct. at 2885 (“the exclusive focus [of the Exchange Act’s prohibition is]

on domestic purchases and sales”). 16 See In re BP p.l.c. Sec. Litig., No. 10-md-2185, 2012 WL 432611, at *68 (S.D. Tex. Feb.

13, 2012) (noting that the U.S. citizenship of the investors involved does not satisfy the “domestic transaction” requirement); In re Vivendi Universal, 765 F. Supp. 2d at 532 (“Though the Supreme Court in Morrison did not explicitly define the phrase ‘domestic transactions,’ there can be little doubt that the phrase was intended to be a reference to the location of the transaction, not to the location of the purchaser . . . .”); In re BP, 2012 WL 432611, at *68 (observing that investments in foreign stock solicited in the United States or orders for such stock placed in the United States do not satisfy Morrison’s domestic transaction requirement) (citing authority); In re UBS, 2011 WL 4059356, at *8 (finding that investor arguments based on injury in the United States are “in essence a re-articulation of the ‘effects’ test [which] was squarely rejected by the Morrison Court”).

Some courts have subscribed to an even more narrow reading of the second Morrison prong, but a recent appellate decision has arguably thrown these holdings into doubt.17 For instance, courts do not universally agree that domestic transactions in securities sold through private placement transactions of public investments in private equity (“PIPEs”) about which representations are made in U.S. securities filings are subject to the Exchange Act. In Absolute Activist Value Master Fund Ltd. v. Homm,18 the district court held that the Exchange Act’s protections did not apply to investors who purchased through PIPEs penny stocks19 quoted on the OTC Bulletin Board or the Pink OTC Markets because the securities were not listed on a U.S. exchange, and the shares were purchased directly from foreign companies. In dicta, the district court noted that Morrison’s holding would appear to limit the application of the Exchange Act to such ADR transactions even when companies are registered with the U.S. SEC.20 However, on appeal, the Second Circuit held that the identity of the security and the fact that it was purchased directly from a foreign company was not controlling.21 Rather, the court focused on the point that irrevocable liability was incurred as well as the location that title was transferred for purposes of determining whether it was a domestic sale under Morrison. The court stated: “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.”22 The Second Circuit’s holding is in accord with two other appellate decisions addressing whether a transaction was “domestic” under Morrison.23 Other Courts have held that purchases and sales of ADRs that take place in the United States and are quoted through the OTC markets may not be subject to the Exchange Act.24 However, “the district court cases holding that swap agreements and ADR purchases in foreign securities do not constitute domestic transactions appear to no longer be good law after Absolute Activist.”25

17 Jay W. Eisenhofer & Geoffrey C. Davis, Second Circuit Clarifies ‘Domestic Transaction’ Under ‘Morrison,’ New York Law Journal (June 2012).

18 Absolute Activist Value Master Fund Ltd. v. Homm, 09-cv-8862, 2010 WL 5415885, at * 5 (S.D.N.Y. Dec. 22, 2010)

19 The term “penny stock” generally refers to low-priced (below $5.00), speculative securities of very small companies.

20 Absolute Activist, 2010 WL 5415885, at * 5 n.7.21 Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2nd Cir. 2012).22 Id. 23 See Quail Cruises Ship Management v. Agencia De Viagens CVC Tur Limitada, 645 F.3d 1307

(11th Cir. 2011); See also S.E.C. v. Levine, 462 Fed.Appx. 717 (9th Cir. 2011).24 See, e.g., In re Sociéte Générale, 2010 WL 3910286, at *6 (finding sua sponte that

transactions in ADRs are predominately foreign in nature). 25 Jay W. Eisenhofer & Geoffrey C. Davis, Second Circuit Clarifies ‘Domestic Transaction’ Under

‘Morrison,’ New York Law Journal (June 2012).



Some post-Morrison courts have taken a hard-line stance against a variety of complex securities transactions that appear to confound the Supreme Court’s attempt to create a clear and simple bright-line test, but others have taken a different view. For instance, in Elliot Associates v. Porsche Automobil Holding SE, the U.S. District Court for the Southern District of New York held that a securities-based swap agreement involving a company’s foreign shares was effectively a transaction on a foreign exchange.26 Notably, the swap agreement at issue was executed in New York and included a choice of law provision applying U.S. law. On its face, the agreement would appear to be a “domestic transaction in other securities.”27 The district court, however, gave little consideration to such nuance, focusing instead on the underlying characteristics of the securities at issue to define the transaction. The recent Absolute Activist appellate court decision calls the Elliot holding into question.

What�are�the�regulatory�effects�of�stock�exchange�mergers?�The Morrison decision emphasizes that the Exchange Act covers transactions in securities “listed on an American stock exchange” or “national securities exchanges,”28 which may be read to require that the subject stock exchange be a U.S. entity that conducts it’s trading in the U.S.

In contemplating the recent merger attempt between the NYSE and the Deutsche Börse, Duke University School of Law Professor James D. Cox cautioned that if the NYSE’s trading computer were located in Frankfurt, Germany, purchasers of NYSE-listed stock would not be able to bring a fraud suit under U.S. law based on Morrison.29 As Georgetown University Law Center Professor Donald C. Langevoort has explained, stock exchange mergers “will eventually lead to the demise of either ‘listings’ or ‘trading location’ as a basis for [legal and regulatory] jurisdiction.”30 Because E.U. regulators have rejected the proposed merger between the NYSE and the Deutsche Börse, these hypotheses have not yet been put to any legal test.

26 See Elliot Associates v. Porsche Automobil holding SE, 759 F. Supp. 2d 469, 476 (S.D.N.Y. 2010).

27 Morrison, 130 S.Ct. at 2884.28 Morrison at 2888, 2885 (emphasis added)29 Jeffrey R. McCord, New York Stock Exchange Sale to Deutsche Boerse Will Raise Fraud Risks

for U.S. Investors, The Investor Advocate, May 12, 2011. 30 Id.

Ways To Buy “International” Stocks On U.S. Exchanges: American Depositary Receipts (ADRs)The most common method for U.S. investors to purchase foreign securities in the U.S. is through American Depositary Receipts (ADRs).

ADRs�Generally An ADR is a negotiable instrument issued by a depositary bank representing beneficial ownership in a certain number of ordinary shares of a non-U.S. company. The underlying shares of the foreign issuer, which are represented by the ADR in the U.S., are referred to as American Depositary Shares (“ADS”) and are held by a custodian bank in the issuer’s home country.31

ADR trading has simplified the purchase and sale of foreign securities for U.S. investors by eliminating foreign regulatory and currency exchange issues inherent in trading foreign- registered securities overseas. ADRs can be freely traded between U.S. investors through depositary banks in the same manner as other U.S. securities (i.e., trades are settled and cleared in the U.S.). This avoids inconvenient foreign securities transfer procedures and varying registration requirements present in many foreign countries. ADRs are also quoted and traded in U.S. dollar denominations, and dividends on the underlying foreign shares are paid in dollars and transmitted by the depositary banks directly to ADR holders. The depositary banks also inform ADR holders of the foreign company’s recapitalization plans, security exchange offers, proxy voting matters, and other significant company developments.

Generally, there is no difference between owning an ADR and owning the underlying shares of a foreign issuer. U.S. investors should exercise caution, however, when purchasing ADRs. Specifically, each ADR is subject to the terms of a depositary agreement between the foreign issuer and the U.S. depositary bank. Further, the laws of the foreign issuer’s home country may affect various shareholder rights, including voting rights and proxy limitations.

Overall, ADRs have allowed U.S. investors to diversify their portfolios through increased international investment without the expense of using a foreign broker or depositary. There were over 400 sponsored ADRs listed on U.S. securities exchanges at the end of 2011.32 ADR trading amounted to approximately $1.6 trillion in value and 65 billion in volume during the first half of 2011. As ADR programs continue to grow, they will become increasingly important investments 31 Each ADR generally represents one or more ADS, and each ADS represents a number or

fraction of underlying shares in the foreign company.32 The most actively traded ADRs listed on U.S. exchanges (by value) for 2011 included

Chinese internet company Baidu Inc., Brazilian oil company Petrobras, Teva Pharmaceutical Industries, Ltd. based in Israel, and the U.K. companies British Petroleum plc and Royal Dutch Shell plc. Other highly liquid ADRs listed in the U.S. for 2011 included companies such as Nokia Corp., Vodafone Group plc, and Novartis AG.



for U.S. pension systems and other institutional investors. Accordingly, their treatment under Morrison and its progeny is an important issue going forward.

Types�of�ADRs ADRs fall into two basic categories: (i) “unsponsored” and (ii) “sponsored.” Each has different characteristics and regulatory requirements under U.S. securities laws, which are briefly discussed below.

Unsponsored ADRs Unsponsored ADRs are issued by a depositary bank without the participation or consent of the foreign issuer of the underlying securities. ADRs (both unsponsored and sponsored), however, cannot be issued unless the foreign company is either (i) subject to the periodic reporting requirements of the Exchange Act, or (ii) exempt from such reporting requirements under Rule 12g3-2(b) of the Exchange Act.33

Unsponsored ADRs are not listed on U.S. securities exchanges and trade in the OTC market only. The U.S. OTC market consists of a large network of broker-dealers that hold securities inventories to buy and sell for their own accounts or their customers’ accounts. There are usually several broker-dealers making a market in a given OTC-traded ADR at a given time. Company information and prices for OTC-traded ADRs can be found in the National Quotation Bureau’s “pink sheets,” or the OTC Bulletin Board. Both provide wholesale price quotes for OTC stocks listed by market makers in individual securities.

Often more than one depositary bank issues the same unsponsored ADR since they are created without the consent of the foreign issuer of the underlying securities. The unilateral ability of depositary banks to issue unsponsored ADRs (assuming the above requirements are satisfied) allows them to quickly respond to increased U.S. investor/broker demand for a particular foreign issuer’s equity securities. Depositary banks issuing unsponsored ADRs, however, have no obligation to provide investors with information or shareholder communications from the foreign issuers of the underlying securities. There are also no additional reporting requirements under U.S. securities laws for unsponsored ADRs traded on the OTC market.

The foreign issuer has no formal agreement with a U.S. depositary bank; they may, however, maintain informal relationships with a number of depositary banks. As a result, any number of depositary banks can create ADRs for the foreign issuer – and they do so based on market 33 Rule 12g3-2(b) provides an automatic exemption from the registration and reporting

requirements of the Exchange Act if the foreign private issuer (i) has not publicly offered or listed securities in the U.S., (ii) has a class of securities traded in a non-U.S. jurisdiction representing over 55% of the issuer’s worldwide trading volume, and (iii) has electronically published English translations of material information made public or filed with securities exchanges under the laws of its home country (i.e., annual reports, interim financial statements, press releases, etc.).

demands (if there is demand for a specific ADR, the depositary bank can purchase shares of the foreign issuer on its home exchange, transfer them to its local custodian, and issue corresponding ADRs in the U.S.). It is important to note, though, that each ADR is specific to the depositary bank that issued it – so an unsponsored ADR issued by BNY Mellon is not interchangeable with an unsponsored ADR issued by Citibank. This lack of interchangeability can often make trading more cumbersome (a problem that doesn’t exist with sponsored ADRs, since they all come from the same depositary bank).

As of 2011 year-end there were approximately 1,284 different unsponsored ADR programs available in the global market.34 Despite this volume, unsponsored ADRs may be considered less favorable to U.S. investors given the lack of information and control by the foreign issuers.

Sponsored ADRs Sponsored ADRs are issued by a depositary bank pursuant to an agreement with the foreign issuer of the underlying equity securities (deposit agreement). Sponsored ADRs are issued by a single depositary bank, often with the financial assistance and at the direction of the foreign securities issuer. There are three levels of sponsorship. Levels I and II relate to foreign shares already issued and are designed to create a U.S. trading market for these outstanding foreign shares. Level III ADRs concern new offerings of foreign securities. Each level involves varying registration and reporting requirements under U.S. securities laws.

Level I ADRs are not listed on U.S. exchanges and are traded on the OTC market only. Consequently, Level I ADRs are not required to be registered under Section 12(b) of the Exchange Act. There is also no requirement to register Level I ADRs under Section 12(g) of the Exchange Act, assuming the requirements of Rule 12g3-2(b) are met.35 Level I ADRs also have minimal SEC reporting requirements, i.e., the foreign issuer is not required to issue quarterly or annual reports in compliance with U.S. Generally Accepted Accounting Principles (GAAP).

Notwithstanding these exemptions, the depositary bank issuing Level I ADRs must still register the ADRs under the Securities Act of 1933 (Securities Act). This registration statement (SEC Form F-6) does not require comprehensive information regarding the foreign company and is usually limited to a copy of the deposit agreement and ADR certificate.

Level I ADRs are appealing to foreign companies that want to introduce their securities to U.S. capital markets

34 Some of the most liquid unsponsored programs at the end of 2011 included ADRs for companies such as Xstrata plc ($185.8m in trading volume), CIE Financiere Richemont SA ($89.6m), Man Group plc ($59m), BMW ($39.1m), and Alstom SA ($33.3m).

35 See Footnote 33.



without subjecting themselves to the listing and registration requirements involved in an initial public offering in the U.S.

Level II ADRs are listed and traded on U.S. securities exchanges (i.e., NYSE or NASDAQ). A foreign company issuing Level II ADRs must meet the registration requirements of both the Exchange Act and the Securities Act. Specifically, Level II ADRs require the filing of a Form F-6 and the more comprehensive annual registration statement under Form 20-F of the Exchange Act. Form 20-F requires essentially the same level of detailed information as a Form 10-K for a U.S. company. A foreign company sponsoring Level II ADRs is also required to follow U.S. GAAP (or International Financial Reporting Standards) in its reported financial statements. In addition, the foreign company must comply with the financial reporting requirements of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).

Level II ADRs have the advantage of being traded on the more widely accessible U.S. securities exchanges, and provide greater foreign company disclosure to U.S. investors. Level II ADRs traded on U.S. exchanges do not involve any newly issued common stock of the foreign company (i.e., they are limited to the currently issued and outstanding stock of the foreign company).

Level III ADRs are listed and traded on U.S. securities exchanges, but unlike Level II ADRs, they represent new shares of the foreign company which are being publicly offered to raise capital in the U.S. Thus, a foreign company issuing Level III ADRs is not simply allowing outstanding shares from its home market to be deposited (and traded) with a depositary bank in the U.S., it is issuing new shares into the U.S. market.

Accordingly, Level III ADRs have more stringent reporting and registration requirements than Level II ADRs. Level III ADRs require the filing of a Securities Act registration statement under Form F-1, which provides detailed company information akin to an offering prospectus for new shares. The filing of a Form F-6 under the Securities Act is also required for Level III ADRs. In addition, the foreign company must file a Form 20-F under the Exchange Act and must comply with the accounting standards under U.S. GAAP or IFRS. Any material company information provided to shareholders under relevant securities regulations in the foreign market must also be filed with the SEC through Form 6-K under the Exchange Act. Level III ADRs also require compliance with Sarbanes-Oxley requirements.

Level III ADRs tend to generate greater interest by U.S. investors given their more regulated nature, and the fact that they involve raising new capital by foreign securities issuers.

Surviving�the�Jurisdictional�Hurdle�of�Morrison’s Transactional�Test ADRs may prove to be an institutional investor’s best tool for circumventing the jurisdictional limits imposed by Morrison’s Transactional Test when investing in foreign companies. Most post-Morrison courts have treated sponsored ADRs favorably, largely excluding them from their jurisdictional analysis.36 Given their varied forms, though, it is not surprising that some lower courts have struggled to properly apply Morrison’s Transactional Test to certain classes of ADRs. For example, in September 2010, The Southern District of New York dismissed the Rule 10b-5 claims of purchasers of unlisted ADRs sua sponte in In re Societe Generale Securities Litigation, despite engaging in only limited analysis and employing a questionable understanding of the ADRs at issue.37

One major question regarding all forms of ADRs that courts must resolve is what exactly is the “transaction” to which the Morrison Transactional Test applies? Since an ADR is a hybrid security, it is possible that the transaction at issue could be either the depositary bank’s initial acquisition of the underlying foreign shares, or an investor’s purchase of the ADR in the U.S. following its creation. How courts choose to resolve this question will have a significant impact on the rights of ADR investors.

Applying�the�Transactional�Test�to�ADR�Purchasers While this is currently an open question, the plain language of the Morrison Transactional Test indicates that it must apply to the purchase of the ADR – and not an earlier transaction between the foreign issuer and U.S. depositary bank. Fundamental to this analysis is the recognition that ADRs are distinct and unique securities which have a character and identity that is independent from the foreign shares to which they are tied. Moreover, transactions in ADRs are inherently different from transactions in the underlying foreign shares. They involve unrelated purchasers and are subject to separate market pressures.

Under this view, transactions involving all three levels of sponsored ADRs should satisfy one of the two prongs of Morrison’s Transactional Test. Specifically, Level II and III ADR transactions satisfy the first prong of the test, because they involve securities “listed on an American stock exchange;” Level I ADR transactions satisfy the second prong of the test, since they are executed in the U.S. by a U.S. depositary bank. Further, all three are subject to some form of regulation by the SEC. As a result, the foreign issuers of sponsored ADRs are precisely the sort of entities

36 See, e.g. In re Alstom SA Securities Litigation, 741 F. Supp. 2d 469, 471 (S.D.N.Y. 2010); Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620, 622 (S.D.N.Y. 2010); Stackhouse v. Toyota Motor Co., No. 10-0922, 2010 WL 3377409, at *2 (C.D. Cal. July 16, 2010).

37 See In re Societe Generale Securities Litigation, 2010 WL 3910286, at *6 (S.D.N.Y. 2010).



to which extraterritorial application of the U.S. securities laws is appropriate.

Moreover, applying the U.S. securities laws to the issuers of sponsored ADRs will not undercut the Supreme Court’s rationale for creating the Transactional Test. As discussed above, courts have taken an expansive view of Morrison, stressing the legal concerns and priorities that underpin the Supreme Court’s decision.38 Notably, post-Morrison courts have given great weight to the various goals espoused by the Supreme Court, including respect for international comity.39 In part, the Supreme Court cautioned that extraterritorial application of U.S. securities laws to foreign companies had the potential for wreaking havoc on foreign regulatory regimes by creating a morass of competing laws.40

None of the Supreme Court’s concerns, however, are implicated by providing U.S. courts with extraterritorial jurisdiction over the foreign issuers of sponsored ADRs, since they have affirmatively sought out access to U.S. capital markets and U.S. investors.41 Such calculated decisions have significant consequences, among which is that the foreign issuer must comply with U.S. securities laws and should be expected to submit to the jurisdiction of U.S. courts when called to account for wrongdoing. Exempting them from the jurisdiction of U.S. courts would only serve to undermine U.S. securities laws and the U.S. regulatory regime, effectively voiding U.S. law in the name of international comity. Currently, though, investors must proceed with caution when purchasing Level I ADRs. In 2010, the Southern District of New York ruled in In re Societe Generale that transactions in Level I ADRs fall outside the jurisdictional bounds of the Exchange Act.42 The Southern District’s holding largely relied on an earlier case, Copeland v. Fortis, which characterized ADR sales as “predominantly foreign securities transactions.”43

The In re Societe Generale court’s analysis, however, suffers from considerable flaws. As a primary matter, the court mischaracterized the ADR transaction at issue as largely indistinguishable from the purchase or sale of the underlying foreign shares.44 Furthermore, the court improperly relied on its determination that U.S.-resident buyers had lower exposure to the defendant’s ADRs since they were not traded 38 See, e.g. Morrison v. National Australia Bank, 130 S.Ct. 2869, 2885-86 (2010); In re Banco

Santander Securities–Optimal Litigation, 732 F. Supp. 2d 1305, 1317 (S.D. Fla. 2010); Stackhouse, 2010 WL 3377409, at *1.

39 See Morrison, 130 S.Ct. at 2885-86.40See id.41See Stackhouse, 2010 WL 3377409, at *1. The U.S. District Court for the Southern District

of New York recently provided similar analysis: When a foreign issuer decides to access U.S. capital markets by listing and trading ADRs,

it subjects itself to SEC reporting requirements, and it would not be illogical to subject that company to the antifraud provisions of the Exchange Act at least where there is a sufficient nexus to the United States. Indeed, that premise underlies both the conduct and effects tests and the Morrison bright line test. Although these standards diverge on the issue of extraterritoriality, as Justice Scalia noted, transnational transactions have both domestic and foreign aspects and the issue becomes one of line-drawing under either test.

In re Vivendi Universal, S.A. Securities Litigation, 765 F. Supp. 2d 512, 528 (S.D.N.Y. 2011).

42 See In re Societe Generale, 2010 WL 3910286, at *6.43 Copeland v. Fortis, 685 F.Supp.2d 498, 506 (S.D.N.Y. 2010).44 See In re Societe Generale, 2010 WL 3910286 at *6.

on a formal U.S. exchange.45 Such reasoning shows little understanding of the pervasiveness of sponsored ADRs and even less understanding of the Morrison Transactional Test.

However, the recent Absolute Activist Second Circuit decision appears to be a positive development when it comes to ADR purchases. The Absolute Activist case seems to indicate that the district court cases, such as In re Societe Generale, that held ADR purchases in foreign securities do not constitute domestic transactions are no longer good law.46 The Second Circuit held that “a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States”47 in order to determine whether the ADR purchase was domestic.

Applying�the�Transactional�Test�to�a�U.S.�Depositary�Bank’s�Acquisition�of�Foreign�SharesDespite the Supreme Court’s plain language, courts may choose to apply the Morrison Transactional Test to the depositary bank’s initial acquisition of the underlying shares, stressing the foreign nature of an ADR and ignoring the practical elements of the ADR purchaser’s transaction. This approach provides a ready-made rationale for courts that increasingly have become predisposed to disfavor cases with significant foreign elements.48 Recent cases, such as In re Societe Generale and Elliot Associates v. Porsche Automobil Holding SE, are emblematic of a troubling trend in which the foreign characteristics of the securities at issue define the transaction and guide the courts’ analysis.49

In particular, transactions involving Level I ADRs provide fertile ground for such an approach, since they occupy an uncomfortable gray zone that requires courts to engage in nuanced analysis. Cases like In re Societe General have demonstrated that the complex nature of a Level I ADR transaction is prone to mischaracterization when not fully understood. This may not be a concern for courts, though, if the Transactional Test is applied to the acquisition of foreign shares by a U.S. depositary bank, obviating the need to review the Level I ADR transaction at issue. Further, the precedent set by In re Societe General, only makes it more likely that courts will choose to continue in this direction. The flaws of such an approach are exposed, however, when it is applied to specific classes of sponsored ADRs. With regard to Level II and III ADRs, a court would have to engage in a particularly tortured reading of Morrison to conclude that securities “listed on an American stock exchange” fall outside the jurisdictional boundaries of the Exchange Act. Such a perversion of the Transactional Test leads to a patently absurd result and renders its plain language meaningless. 45 See id.46 Jay W. Eisenhofer & Geoffrey C. Davis, Second Circuit Clarifies ‘Domestic Transaction’ Under

‘Morrison,’ New York Law Journal (June 2012).47 Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60 (2nd Cir. 2012).48 See, e.g., Plumbers’ Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 753 F. Supp.

2d 166, 177–78 (S.D.N.Y. 2010); In re Société Générale, No. 08 Civ. 2495, 2010 WL 3910286, at *2; Cornwell, 729 F. Supp. 2d at 624.

49 See, e.g. In re Societe Generale, 2010 WL 3910286, at *6; Elliot Associates v. Porsche Automobil Holding SE, 759 F. Supp. 2d 469, 476 (S.D.N.Y. 2010).



The Supreme Court certainly could not have intended such a twisted application of a test designed for “clarity, simplicity, certainty, and consistency.”50

More importantly, the consequences of such an interpretation would wreak havoc on U.S. securities markets. Foreign companies would essentially be immune from shareholder allegations of fraud in the U.S. Smart domestic companies would immediately de-list their shares from U.S. exchanges and set up headquarters in some legal backwater with ineffective securities laws and an even more ineffective judicial system. As a result, it is unlikely that courts will choose to apply the Morrison Transactional Test to the U.S. depositary bank’s acquisition of foreign shares when analyzing Level II and III ADRs.

Survey�of�Real�Life�Money�Managers�re: ADRs Given the relatively positive treatment of ADRs by courts post-Morrison, institutional investors may be turning to this form of investment more frequently. To get a feel for current trends regarding ADRs in the investment marketplace, two surveys were conducted. The first survey was conducted by Stephen H. Cypen, Esq., who surveyed real life money managers in March 2012. Survey questions included: whether the type of ADR affects the manager’s decision to purchase an ADR rather than common stock, what is the manager’s opinion of the ADR market, is the manager’s purchase decision impacted by whether the ADR is sold in a U.S. market or on an OTC exchange, what are the advantages of purchasing ADRs over foreign common shares, and would the protections of the U.S. securities laws influence your decision to purchase ADRs over common shares from a foreign exchange. The responses to these questions and more are provided at Appendix A, and generally indicate that ADRs can be an effective way to access international equity markets. However, several of the managers noted that the ADR market is somewhat limited so investors may not be able to invest in all of the foreign companies that they would like to through the use of ADRs.

The second survey was conducted by Adam L. Franklin, Esq., who spoke with Colorado PERA’s Director of Equities, Jim Liptak. The questions and answers of that survey are provided at Appendix B, and addressed whether it would be possible for an institutional investor to invest solely in ADRs and what some of the reasons might be that an investor would choose an ADR versus common stock.

50 Conwell, 729 F. Supp. 2d at 624.

So You Bought Your International Stock Overseas—Now What? Alternatives to Section 10(b) claimsSince the Morrison decision in 2010, entities have explored alternatives to bringing Section 10(b) claims. This section provides an overview of some of these new strategies.

Implementing�a�Settlement�in�the�Netherlands Following Morrison, one alternative to a Section 10(b) claim is to secure a settlement in the U.S. (or elsewhere) and implement it in the Netherlands. A recent decision by the Amsterdam Court of Appeal in the Converium case illustrates that this can be done successfully.

Converium Holding (Switzerland) AG (now called SCOR Holding (Switzerland) AG) is a Swiss reinsurer, with common shares trading on the SWX Swiss Exchange and with ADRs listed on the NYSE. In October 2004, investors brought suit in the Southern District of New York against Converium and certain of its officers and directors.51 The plaintiffs alleged that the defendants had misrepresented the sufficiency of the company’s loss reserves, which were hundreds of millions of dollars less than needed to cover Converium’s exposure to reinsurance claims.52 In a pre-Morrison decision, the court applied the Conduct and Effects tests to hold that it lacked subject matter jurisdiction over the claims of foreign investors who purchased their shares on the Swiss exchange.53 The case proceeded as to the claims of investors (foreign or domestic) who purchased ADRs on the NYSE and U.S. residents who purchased common shares on the Swiss exchange.54 That portion of the case was settled for $84.6 million and the settlement was effectuated in the Southern District of New York through the familiar procedures.

In July 2010, Converium entered into settlement agreements with non-U.S. purchasers (i.e., those purchasers who had been excluded from the U.S. class action) under which it agreed to pay $58.4 million. A petition was filed with the Amsterdam Court of Appeal under the Dutch Act on the Collective Settlement of Mass Claims (the Wet Collectieve Afwikkeling Massaschade; the “WCAM”). The WCAM, implemented in the Netherlands in 2005, provides a mechanism for collective resolution of claims on a global basis. It is a limited mechanism however; it is not a litigation statute and can only be utilized after the parties have reached a settlement of their claims.

51 See In re Scor Holding (Switz.) AG Litig., 537 F. Supp. 2d 556, 559 (S.D.N.Y. 2008).52 Id.53 Id. at 560-69.54 Id. at 560.



On November 12, 2010, the Court issued a provisional decision in which it assumed jurisdiction to declare the settlements binding on non-U.S. purchasers. The Court’s reasoning was substantially similar to its jurisdictional ruling in its prior Shell decision (however, in that case, there was a much closer connection to the Netherlands because the case involved a Dutch and a British entity). The Amsterdam Court of Appeal in Converium emphasized the fact that a Dutch foundation represented the investors and would be distributing the settlement proceeds. Notably, the decision expressly referred to the inability of U.S. courts to secure global relief due to the Morrison decision. The Court’s ruling was provisional and permitted interested persons to object to the settlements, similar to the process in the U.S.

On January 17, 2012, the Court confirmed its provisional decision on jurisdiction and declared the settlement agreements binding. The Court also rejected various objections to the settlement, including arguments that the amount of the settlement relief was insufficient and that the attorneys’ fees were too high. As to the latter objection, the Court held that it was proper to take into account customary and reasonable billing rates in the U.S. given that a substantial portion of the work had been completed in the U.S. The Court also ruled that the representativity test had been met because the Dutch foundation representing the investors had various participants (including shareholder associations and institutional shareholders) domiciled in Switzerland and the U.K., where most of the non-U.S. investors were domiciled.

The Converium decision is especially significant in the wake of Morrison because it provides a mechanism for investors on non-U.S. exchanges to enter into global resolution of claims even where the parties and the underlying facts at issue have only a limited connection to the Netherlands. In Converium, even though the alleged wrongdoing took place outside the Netherlands, most of the investors resided outside the Netherlands, and Converium was a Swiss company and its shares traded on the Swiss stock exchange (and not in the Netherlands), the Court held the settlement agreements binding on investors worldwide. Under the Lugano Convention and the Brussels Regulation, the decision must be recognized throughout the European Union, as well as in Switzerland, Iceland, and Norway.

The WCAM is the only European statute that permits a court to declare a settlement binding on all class members on an opt-out basis. This makes the Netherlands a unique forum for implementing global settlements, even when the underlying litigation took place elsewhere and when

the facts of the case lack any strong connection to the Netherlands.

Non-Federal�Securities�Claims

State Law Claims Another option is to litigate in the U.S. but avoid the federal securities laws and, hopefully, avoid Morrison. Plaintiffs have asserted, with some limited success, state law claims for purchases of securities occurring outside the U.S. There are numerous difficult issues that must be carefully considered before pleading state law claims.55

SLUSA Preemption Any mention of a state law securities action should raise concerns of possible preemption by the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”). SLUSA prohibits the use of a class action to bring state law claims alleging securities fraud.56 As the court stated in In re Worldcom, Inc. Sec. Litig., “SLUSA was enacted to close the [state class action] loophole by mandating federal courts as the exclusive venue for class actions alleging fraud in the sale of certain covered securities and by mandating that such class actions be governed exclusively by federal law.”57 SLUSA is not meant to prevent plaintiffs from asserting state law causes of action in state or federal court in individual actions; it is only meant to prevent a securities class action exodus from federal court, where the more restrictive PSLRA applies.58 Specifically, the statute provides:

No covered class action based upon the statutory or common law of any State or subdivision thereof may bemaintained in any State or Federal court by any private party alleging—

(A) a misrepresentation or omission of a material fact in connection with the purchase or sale of a covered security; or

(B) that the defendant used or employed any manipulative or deceptive device or contrivance in connection with the purchase or sale of a covered security.59

55 The two most obvious types of state law claims that could apply to securities transactions are common law fraud and state securities statutes (i.e., blue sky laws). Other possibilities include other varieties of common law claims, such as negligent misrepresentation and unjust enrichment.

56 See 15 U.S.C. § 78bb(f )(1).57In re Worldcom, Inc. Sec. Litig., 308 F. Supp. 2d 236, 242 (S.D.N.Y. 2004) (citation

omitted).58Dabit, 547 U.S. at 87 (“[SLUSA] does not deny any individual plaintiff, or indeed any

group of fewer than 50 plaintiffs, the right to enforce any state-law causes of action that may exist.”); see also Kircher v. Putnam Funds Trust, 547 U.S. 633, 636 n.1 (2006).

59Id.



Is the Subject Security a “Covered Security?” One question to consider is whether the foreign securities at issue in your case are “covered securities” under SLUSA. If not, SLUSA might not preempt the state law class action.60 SLUSA defines “covered security” by referencing section 18(b) of the Securities Act, which states in part:

[T]he following are covered securities:

(1) Exclusive Federal registration of nationally traded securities. A security is a covered security if such security is—

(A) listed, or authorized for listing, on the New York Stock Exchange or the American Stock Exchange, or listed, or authorized for listing, on the National Market System of the Nasdaq Stock Market (or any successor to such entities);

(B) listed, or authorized for listing, on a national securities exchange (or tier or segment thereof) that has listing standards that the Commission determines by rule (on its own initiative or on the basis of a petition) are substantially similar to the listing standards applicable to securities described in subparagraph (A); or

(C) is a security of the same issuer that is equal in seniority or that is a senior security to a security described in subparagraph (A) or (B).61

Subparagraphs (A) and (B) consider whether a security is “listed” or “authorized for listing” on certain U.S. exchanges or “on a national securities exchange” with comparable listing standards. The statute does not define the term “national securities exchange,” but the structure of the statute makes clear that the phrase “national securities exchange” includes only domestic securities exchanges.62

60 In some cases, SLUSA could preempt your claim even if the securities purchased by the plaintiff are not “covered securities.” SLUSA preempts a claim as long as the complaint pleads fraud in connection with a covered security – even if the covered security is not the security on which the claims are based. In U.S. Mortgage, Inc. v. Saxton, 494 F.3d 833, 845 (9th Cir. 2007), the Ninth Circuit held that state-law fraud claims alleging misrepresentations in a publicly traded company’s regulatory filings were precluded by SLUSA—although plaintiffs’ claims arose from transactions in privately negotiated debt securities that were not “covered securities.” The court concluded that “the alleged harm stems from misrepresentations in [defendant’s] public filings and public statements,” which “undoubtedly ‘coincide’ with the purchase or sale of [defendant’s] publicly traded shares, and those shares are clearly ‘covered securities’ under SLUSA.” Id.

61 15 USCS § 77r(b).

62 Specifically, Section 77r falls within a part of the code titled “domestic securities” while a separate part of the code deals with “foreign securities.” Also, there is a separate section titled “Foreign securities exchanges,” the existence of which suggests that “national securities exchanges” does not include foreign securities exchanges. See 15 U.S.C. § 78dd; see also Roth v. Fund of Funds, Ltd., 279 F. Supp. 935, 936 (S.D.N.Y. 1968) (“The heading of [15 U.S.C. § 78dd] refers to ‘foreign securities exchanges’ and obviously refers to activities on such exchanges.”). Finally, there are several regulations that apply to “national securities exchanges” which would not conceivably apply to foreign exchanges. See, e.g., 15 U.S.C. § 78f (providing for the registration with the SEC of national securities exchanges and otherwise regulating such exchanges); see also 15 U.S.C. §§ 78g, 78i, 78k.

Therefore, a stock listed on a foreign exchange would not normally be considered a “covered security.”

However, there are certain limited circumstances under which stock listed on a foreign exchange could be considered a “covered security,” so caution must be exercised when analyzing SLUSA. For example, foreign shares are sometimes listed on a U.S. exchange in connection with a foreign company’s ADR program. The foreign shares are considered “covered securities” even though they are not actually traded on the U.S. exchange. The plaintiffs in In re BP P.L.C.,63 pled New York common law fraud claims based on purchases of BP ordinary shares, which trade on the London Stock Exchange.64 The court held that SLUSA preempted the claim, because the ordinary shares were technically “listed” on the New York Stock Exchange in connection with BP’s ADR program.65 The court rejected the argument that a security must also be traded – not merely listed – in order to be subject to SLUSA.66

One must also consider subparagraph (C) of the “covered securities” definition, which states that a security is a covered security if it “is a security of the same issuer that is equal in seniority or that is a senior security to a security described in subparagraph (A) or (B).”67 A senior security is one that has “priority over another class as to the distribution of assets or the payment of dividends.”68 Therefore, if the issuer of the foreign shares also issues other securities that trade on a U.S. exchange, the foreign shares would be considered “covered securities.”

If the foreign shares at issue do not qualify as “covered securities” (and if the complaint does not allege that the defendants made misrepresentations in connection with the purchase or sale of any other covered security), it does not appear SLUSA will bar a class action based on state law claims alleging securities fraud.

Is the Action a “Covered Class Action?” SLUSA applies only to “covered class actions” which it defines to include not just formal class actions, but also “any group of lawsuits filed in or pending in the same court” involving common questions of law or fact, seeking damages on behalf of more than 50 persons, and which are “joined, consolidated, or otherwise proceed as a single action for any purpose.”69 Therefore, if you bring an action on behalf of 50 or fewer investors, SLUSA will normally not apply. Note that at least one court has held that SLUSA preemption applies to individual actions that have been consolidated with a separate class action.70 Defendants may remove a state 63 2012 U.S. Dist. LEXIS 17788 (S.D. Tex. Feb. 13, 2012).64 Id. at *232.65 Id. at *233-34.66 Id. at *234.67 15 USCS § 77r(b)(1)(C).68 In re Metro. Secs. Litig., 532 F. Supp. 2d 1260, 1298 (E.D. Wash. 2007).69 15 U.S.C. § 78bb(f )(5)(b).70 See In re Fannie Mae Sec. Litig., 503 F. Supp. 2d 25, 32-33 (D. D.C. 2007); see also In re

Enron Corp. Sec., Derivative & MDL-1446 “ERISA” Litig., No. 01-3624, 2006 U.S. Dist.



court action to federal court where it is then consolidated with similar actions and dismissed under SLUSA.71 Therefore, even if you file an individual action, it could potentially be consolidated with a separate class action and dismissed under SLUSA.

SLUSA’s State Pension Plan Exemption Importantly, SLUSA excludes cases brought by states or state pension plans from its definition of “covered class actions.” Specifically, SLUSA provides:

Notwithstanding any other provision of this section, nothing in this section may be construed to preclude a State or political subdivision thereof or a State pension plan from bringing an action involving a covered security on its own behalf, or as a member of a class comprised solely of other States, political subdivisions, or State pension plans that are named plaintiffs, and that have authorized participation, in such action.72

“State pension plan” is specifically defined as “a pension plan established and maintained for its employees by the government of a State or political subdivision thereof, or by any agency or instrumentality thereof.”73

Under the plain meaning of SLUSA, any pension fund established by a state, its agencies and instrumentalities for their employees may claim the exception.74 15 U.S.C.§ 78bb(f)(3)(B)(ii). As noted above, it seems clear that a State pension plan can proceed with state law claims under the state action exception and without fear of SLUSA preemption.

Such a complaint cannot be styled as a class action, however. The complaint must be drafted to make clear that the state entity-plaintiff is proceeding on its own behalf and that it does not seek to assert claims on behalf of additional, similarly-situated state entities unless they have specifically authorized the suit. The complaint must also make clear that the recovery sought will go to the fund directly and not its members.

Because actions by state entities are immune to SLUSA, an unlimited number of state entities may join their claims in a single suit, provided each has specifically authorized the action. “The effect of the state-actions exception (as its plain language indicates) is to bring only those suits that are brought on behalf of fifty or more states, political subdivisions, or state pension plans that are named plaintiffs outside of SLUSA’s otherwise broad preclusive reach under this grouping provision.” 75

LEXIS 90526 (S.D. Tex. Dec. 12, 2006); In re WorldCom, Inc. Sec. Litig., 308 F. Supp. 2d 237, 247 (S.D.N.Y. 2004) (holding that ten individual actions collectively seeking damages on behalf of more than fifty plaintiffs formed a covered class action).

71 WorldCom, 308 F. Supp. 2d 241.72 15 U.S.C. § 77p(d)(2)(A).73 15 U.S.C. § 78bb(f )(3)(B)(ii).74 15 U.S.C.§ 78bb(f )(3)(B)(ii).75 Demings v. Nationwide Life Ins. Co, 593 F.3d at 494.

The following cases are examples of how the State pension plan exception has been applied.

• City of Chattanooga, Tennessee v. Hartford Life Ins. Co. In City of Chattanooga, the sponsor of the City of Chattanooga, Tennessee Deferred Compensation Plan brought state law claims in federal court for breach of fiduciary duty and unjust enrichment in connection with its investments in variable annuity contracts made through defendants.76 The City styled its complaint as a class action “on behalf of its pension plan and all other similarly-situated pension plans[.]”77 Defendants moved to dismiss, claiming SLUSA preemption. The court found that all the elements for SLUSA preemption were met and dismissed the complaint without prejudice to repleading in line with the state action exception.78

The court rejected the plaintiff ’s initial invocation of the state action exception because it brought its claims as a class action. Instead, the court accepted defendants’ argument that “the exception applies only where the class is composed of named plaintiffs that have authorized participation.”79

The court reached its conclusion based on its “plain language” analysis of the statute and rejected Chattanooga’s argument that the state action exception operated as an “opt-in” provision by which other state entities could join the action.80 While the court granted the motion to dismiss, it also granted Chattanooga leave to amend in order to bring its complaint within the state action exception (presumably by recasting the complaint as an individual action, as opposed to a class action).81

• In re Hollinger International, Inc. In Hollinger, three plaintiffs filed an eight count class action complaint in federal district court.82 Two plaintiffs were pension plans, (the Teachers’ Retirement System of Louisiana (Teachers) and the Washington Area Carpenters Pension and Retirement Fund (Washington Carpenters) and one was a private individual (Carlson). Three of the alleged claims were Illinois state law claims: (1) breach of fiduciary duty, (2) violations of Illinois Securities Law, and (3) aiding and abetting breach of

76 City of Chattanooga, Tenn. v. Hartford Life Ins. Co., No. 3:09cv516, 2009 U.S. Dist. LEXIS 119930, at *4-5 (D. Conn. Dec. 15, 2009).

77 Id. at *1.78 Id. at *7-8.79 Id. at *9. 80 Id. at *10 (“SLUSA . . . indicates that the state entity must have ‘authorized’ its

participation at the time the action is brought.”) Id. (citation omitted). 81 Id. 82 In re Hollinger Int’l, Inc., Sec. Litig., No. 04C-0834, 2006 U.S. Dist. LEXIS 47173, at *5-6

(N.D. Ill. June 28, 2006).



fiduciary duty. The remaining claims arose out of the Exchange Act.

Defendants moved to dismiss the state law claims on SLUSA preemption grounds. The court rejected defendants’ argument that the Illinois Securities Law claim did not fall within the state action exception. (“[T]he complaint fairly alleges that Teachers and Washington Carpenters are state pension plans.”)83 The court nevertheless dismissed that claim under the Illinois Securities Law itself, but with leave to amend. It admonished the plaintiffs to “exclude any plaintiffs [i.e Carlson] who are not state pension plans” when amending their complaint on behalf of the named plaintiffs. (“Plaintiffs may replead as to the named plaintiffs in this case.”)84

• Demings v. Nationwide Life Ins. Co. In Demings, the Sixth Circuit rejected an attempt by a county sheriff to claim the state action exception.85 The complaint, brought in federal court in Ohio on behalf of a deferred compensation plan, was styled as a class action on behalf of “all others similarly situated as sponsors of [deferred compensation] plans.” The Demings court found the class mechanism invoked by the “all others similarly situated” language destroyed the state action exception.86

Under the state action exception, “only class of named plaintiffs that specifically authorized participation in the underlying suit” may belong to a class under the state action exception.87 Congress crafted the state action exception in this manner to avoid creating a loophole for class actions “on behalf of pension funds and municipalities that had no interest in bringing suit.”88

• Instituto de Prevision Militar v. Merrill Lynch Like the sheriff in Demings, the plaintiff in Instituto de Prevision Militar v. Merrill Lynch, had characterized its suit as one on behalf of “a large class of Guatemalan military pensioners.”89 The court found that the claim was preempted under SLUSA and not exempted by the state action exception for two reasons. First, the claim was pled on behalf of a class of pensioners, and not the fund itself—something expressly disallowed by the exception.90

83 The court conducted no analysis beyond this and did not remark on the fact that one of the pension plans appears not to be a state entity, but a union pension fund (Washington Carpenters). The court also did not directly address whether the plaintiffs could assert class claims on behalf of similarly-situated pension plans, although it ostensibly granted leave to amend on behalf of the named plaintiffs only.

84 Id. at *71 85 Demings v. 593 F.3d at 489. 86 Id. at 493. 87 Id. at 494 (citing H.R. 1689, 105th Cong. § 16(d)(2) (July 21, 1998)). 88 This rationale was a secondary one for the court, which rejected the assertion of the state

action exception because the sheriff, not the plan itself, was asserting the claim, which was at odds with the statute. Id. at 492 (citing 15 U.S.C. § 77p(d)(2)(A)).

89 Instituto de Prevision Militar v. Merrill Lynch 2007 U.S. Dist. LEXIS 31066 at *8.90 Id. at *7.

Second, the fund was foreign, and the “exception only applies to pension plans of states in the United States.”91 The court reached the same conclusion in a related case brought by the same foreign pension fund.92 Foreign pension funds may not, therefore, claim the protection of the state action exception. (“[T]his individual exception is addressing the preservation of U.S. state court causes of action in U.S. state courts for the U.S. state pension funds.”)93

Extraterritorial�Application�of�State�LawsMorrison held that the federal securities laws do not have extraterritorial application. Therefore, an important question is whether state laws would apply to conduct occurring, and to plaintiffs residing, outside the state and outside the U.S. Stated differently: when do a particular state’s laws control the conduct of an overseas defendant? This issue overlaps with the choice-of-law question – when an investor sues a defendant for common law fraud, which state’s law applies?

Most of the cases on this issue address whether a particular state’s law can be applied to an out-of-state, but not out-of-country, defendant. However, from a state’s perspective, it should not matter whether the defendant is a citizen of a different state or a different country; either way, it is an out-of-state defendant. Therefore, we should expect the following cases – discussing out-of-state but domestic defendants – to be relevant to the question of whether a state’s laws can be applied to a foreign defendant.

Law of the Plaintiff’s Residence One option is to apply the law of the plaintiff ’s residence (which is often the same as the location where the plaintiffs initiated their purchase). This is akin to the pre-Morrison Effects test. There are several cases in which investors have brought suit under the law of their state of residence. In many of these cases, there is no indication that the defendant engaged in any wrongful conduct within the state. These decisions do not directly address whether it is permissible for an investor to sue a non-resident defendant under a particular state’s law when the only connection to the state is that the plaintiff resides there and the plaintiff initiated the purchase there.94 But the decisions do show that plaintiffs have successfully applied their home state’s law in these situations.

91 Id. at *15. 92 Instituto de Prevision Militar v. Lehman, 485 F. Supp. 2d at 1346. 93 Id. 94 There is dicta in some cases that suggests this is appropriate. See, e.g., Simms Investment

Company v. E.F. Hutton & Co. Inc., 699 F. Supp. 543 (M.D. N.C. 1988) (“Blue Sky laws protect two distinct policies. First, the laws protect resident purchasers of securities, without regard to the origin of the security. Second, the laws protect legitimate resident issuers by exposing illegitimate resident issuers to liability, without regard to the markets of the issuer.”) (emphasis added); Rousseff v. Dean Witter & Co., 453 F. Supp. 774, 778 n.7 (N.D. Ind. 1978) (“Indiana’s securities law is designed to protect investors who operate within the State of Indiana.”).



• In re Fannie Mae Sec. Litig.95 The plaintiffs had filed individual actions after opting out of the federal securities class action. Plaintiffs were residents of Massachusetts and California and sued under their respective state laws. A review of defendants’ brief in support of their motion to dismiss shows that they argued for SLUSA preemption but did not argue that the state laws did not apply to them.

• Booth v. Verity.96 The plaintiffs were two individual Kentucky residents that bought stock in the defendant, a California company. The plaintiffs sued under the Kentucky blue sky law. The court held that there was no personal jurisdiction over the individual defendants because they had not committed any act purposefully directed at Kentucky. After dismissing the claims against the individual defendants, the court proceeded to analyze the merits of the claim against the company, while implicitly assuming that the Kentucky law could properly be applied to the company.

• In re Marsh & McLennan Companies, Inc. Sec. Litig.97 The class action plaintiffs asserted various state law claims, including blue sky law claims, on behalf of a pension fund subclass. The court seemed to assume that either the law of the residences of the plaintiffs or the defendant would control, stating: “Where applicable, citations are provided for Ohio, New Jersey, and New York, the respective residences of the Co-Lead Plaintiffs and [the defendant].”98 The blue sky law claim in the complaint stated: “This Count is brought pursuant to those state securities laws that have a private right of action of each of the states in which the members of the Municipal and State Pension Fund Subclass Plaintiffs are located.” In their brief, the defendants did not argue that the various state statutes did not apply to them, just that “[a] proper choice of law analysis might dictate that New York law applies to all the claims.”

• Beightol v. Navarre Corp., Inc.99 The plaintiff, a Mississippi resident, sued the defendant, a Minnesota company, under the Mississippi Securities Act and for Mississippi common law fraud. The plaintiff conceded that the statute required privity between the plaintiff and defendant, which he had not alleged, but the defendant never argued that it was not otherwise subject to the Mississippi statute. The court found that the plaintiff had adequately pled the negligent misrepresentation and common law fraud claims under Mississippi law.100

95 In re Fannie Mae Sec. Litig., 503 F. Supp. 2d 25 (D. D.C. 2007). 96 Booth v. Verity, 124 F. Supp. 2d 452 (W.D. Ky. 2000).97 In re Marsh & McLennan Companies, Inc. Sec. Litig., 501 F. Supp. 2d 452 (S.D.N.Y. 2006). 98 Id. at 495 n.19.99 Beightol v. Navarre Corp., Inc., 2009 U.S. Dist. LEXIS 6590 (S.D. Miss. Jan. 26,

2009). 100 Id. at *13.

• In re Enron Corp. Sec.101 Ohio pension funds sued in state court and asserted “claims for common law fraud and deceit, aiding and abetting common law fraud, conspiracy to commit fraud, and negligent misrepresentation under Ohio law, as well as violation of the Texas Securities Act[.]”

• In re Worldcom, Inc. Sec. Litig.102 The plaintiffs were a group of New York City pension funds suing under federal and state law. The court applied New York law to the common law fraud claims based on the parties consent to its application.

None of these cases specifically analyze the question of whether the state law could be applied extraterritorially. However, it is encouraging that multiple plaintiffs have sued defendants under their own state’s blue sky law where there was no obvious connection to the state other than the plaintiff ’s residence and the fact that the purchase was initiated there. It is also encouraging that the defendants in these cases did not argue that the law could not be applied to them.

One complication is that a class action typically includes the claims of investors from many different states. There are some favorable pre-SLUSA decisions applying one state’s law to a nationwide class of investors (post-SLUSA decisions on this point are rare because SLUSA all but eliminated state law securities fraud class actions).103

Wrongful Acts Within a Particular State Another option is to apply the law of a particular state if a defendant has committed wrongful acts within that state. This is essentially an application of the pre-Morrison Conduct test to state law.

Courts have applied state laws to claims relating to securities transactions based on a defendants’ actions within that state. In Dandong v. Pinnacle Performance Ltd.,104 the plaintiffs, a group of Singapore investors (but 101 In re Enron Corp. Sec., 465 F. Supp. 2d 687, 692 (S.D. Tex. 2006). 102 In re Worldcom, Inc. Sec. Litig., 382 F. Supp. 2d 549 (S.D.N.Y. 2005). 103 See, e.g., Barkman v. Wabash, Inc., 674 F. Supp. 623, 634 (N.D. Ill. 1987) (rejecting

defendants’ argument that the “court must apply the law of each class member’s residence because the law of the state where each individual member of the class transacted his purchase would govern the common law fraud claim”; instead Illinois applies the “most significant contacts” test in determining choice of law issues); In re Activision Sec. Litig., 621 F. Supp. 415, 430 (N.D. Cal. 1985) (despite differences in elements of common law fraud claims, defendants had not shown why California law would not apply to all claims); In re Victor Technologies Sec. Litig., 102 F.R.D. 53, 59-60 (S.D. Cal. 1984) (certifying nationwide class of stock purchasers alleging federal securities and state statutory and common law claims because the “court will most likely apply California law to all pendent state law claims”); In re Saxon Sec. Litigation, 1984 U.S. Dist. LEXIS 19223, at *11 (S.D.N.Y. Feb. 23, 1984) (“Although we have no specific information on the law governing common law fraud in different states, we doubt whether there are significant variations. Therefore, it may well be reasonable to apply the law of New York to all of the non-residents’ claims, or to allow both sides to explore the possibility of picking another state’s law to be applied uniformly[.]”) (internal citation omitted); Dekro v. Stern Brothers & Co., 540 F. Supp. 406, 418 (W.D. Mo. 1982) (refusing to decertify a class alleging violations of the federal securities laws and common law fraud because “[i]t is conceivable that defendant’s conduct should be evaluated under the law of that state with the most significant contacts to the underlying transaction.”).

104 Dandong v. Pinnacle Performance Ltd., 2011 U.S. Dist. LEXIS 126552 (S.D.N.Y. Oct. 31, 2011).



not a class), sued Morgan Stanley and certain of its affiliates for New York state law claims relating to their purchases of credit-linked notes issued by Pinnacle Performance Limited.105 The plaintiffs bought the notes from various independent distributors in Asia.106 The plaintiffs alleged that Morgan Stanley deliberately invested their principal in risky single-tranche collateralized debt obligations created by Morgan Stanley, which Morgan Stanley had purposely designed to fail.107 The plaintiffs further alleged that Morgan Stanley had taken a short position with respect to the collateral pool of assets underlying the CDOs.108

The court rejected the defendants’ argument that a forum selection clause required the litigation take place in Singapore and denied the defendants’ motion to dismiss on forum non conveniens grounds. In connection with the forum non conveniens ruling, the court held that “the vast majority of actions that Plaintiffs’ allege were fraudulent occurred in New York and London.”109 These actions included Morgan Stanley’s creation of the CDOs (New York), their selection of the assets underlying the CDOs (New York), their selection of the assets underling the notes (London), and their drafting of the offering materials (New York). The court applied New York law to the merits issues because Morgan Stanley had not demonstrated that Singapore law differed from New York law.110 The court sustained the plaintiffs’ claims for fraud, fraudulent inducement, breach of the implied covenant of good faith and fair dealing, but, under the Martin Act, dismissed the claims for negligent misrepresentation, breach of fiduciary duty, and aiding and abetting.111

Diamond Multimedia Systems v. Superior Court of Santa Clara County112 does not involve foreign plaintiffs or foreign securities, but it demonstrates how a state’s law can be used by non-residents given conduct by the defendant within that state. In Diamond, the plaintiff brought a class action under California law on behalf of all purchasers (nationwide) of stock in the defendant corporation, a company with its principal place of business in California.113 The California Supreme Court held that a provision of its blue sky law was available to out-of-state purchasers even if the purchase or sale took place outside of California.114 It was enough that a defendant made a false

105 Id. at *1-2. 106 Id. at *2.107 Id. at *5-6. 108Id. at *6.109Id. at *15. 110Id. at *28.111 Id. at *28-43.112 Diamond Multimedia Systems v. Superior Court of Santa Clara County, 19 Cal. 4th 1036

(1999).113 The case was filed before SLUSA was enacted so, as the Court explained, SLUSA did not

preempt the class action. Id. at 1057.114 Diamond Multimedia, at 1047-48.

statement in California for the purpose of inducing the purchase or sale of stock.115 Notably, the Court stated:

[The defendant] has cited, and we have found, no decisions in the courts of our sister states in which actions on behalf of a nationwide class or out-of-state purchasers of securities brought under state securities laws have been dismissed because plaintiffs did not purchase the securities in the state.116

Issues with State Law Claims There are various obstacles that arise when pleading state law claims which do not present themselves with traditional federal law claims. In particular, common law fraud claims typically do not recognize the fraud-on-the-market presumption of reliance.117

In contrast to common law fraud claims, “[m]any state securities statutes have been . . . interpreted to include a presumption of reliance, or to eliminate the reliance requirement altogether.”118

However, the state securities statutes present their own unique obstacles. Many of these statutes require privity 115 Id. at 1048.116 Id. at 1062.117 See Peil v. Speiser, 806 F.2d 1154, 1163 n.17 (3d Cir. 1986) (“While the fraud on the

market theory is good law with respect to the Securities Acts, no state courts have adopted the theory, and thus direct reliance remains a requirement of a common law securities fraud claim.”); In re Ford Motor Co. Vehicle Paint Litig., 182 F.R.D. 214, 221 (E.D. La. 1998) (“[T]he vast majority of states have never adopted a rule allowing reliance to be presumed in common law fraud cases, and some states have expressly rejected such a proposition.”); Marsh & McLennan, 501 F. Supp. 2d at 496 (“[I]n Ohio, securities plaintiffs must allege their reliance on false representations.”); In re WorldCom, Inc. Sec. Litig., 2006 U.S. Dist. LEXIS 11679, at *18 (S.D.N.Y. Mar. 22, 2006) (“In interpreting their common law, however, courts have declined to create a presumption of reliance for securities’ claims where it would not otherwise exist for common law fraud claims.”); Gaffin v. Teledyne, Inc., 611 A.2d 467, 474 (Del. 1992) (“A class action may not be maintained in a purely common law . . . fraud case since individual questions of law or fact, particularly as to the element of justifiable reliance, will inevitably predominate over common questions of law or fact”); Antonson v. Robertson, 141 F.R.D. 501, 508 (E.D. Kan. 1991) (“[W]ith respect to plaintiffs’ common law fraud claims, in the absence of an analogous state law doctrine of fraud on the market, each individual plaintiff would be required to prove his or her individual reliance, causing individual questions of fact to predominate in the case.”); Mirkin, 5 Cal. 4th at 1100-01 (California common law requires pleading actual reliance): Gavron, 115 F.R.D. at 325 (declining to certify class of Pennsylvania common law fraud claims because “each plaintiff must demonstrate his individual reliance upon the defendants’ misstatements”); Keyser v. Commonwealth Nat. Financial Corp., 121 F.R.D. 642, 649 (M.D. Pa. 1988) (fraud on the market claim unavailable in common law). There are some hints that the fraud-on-the-market presumption could be invoked under New York law, although most New York cases have refused to apply the presumption. Pfizer, 584 F. Supp. 2d at 643 (while there is an “open question” as to whether the fraud-on-the-market theory can be used for New York common law fraud claims, courts in the Southern District of New York “have generally refused to allow plaintiffs to use the fraud-on-the-market theory to support common law fraud claims”).

118 In re WorldCom, Inc. Sec. Litig., 2006 U.S. Dist. LEXIS 11679, at *17-18 (S.D.N.Y. Mar. 22, 2006) (citing Mirkin v. Wasserman, 858 P.2d 568, 579-80 (Cal. 1993); Conn. Nat’l Bank v. Giacomi, 699 A.2d 101, 120 n.37 (Conn. 1997); Allyn v. Wortman, 725 So. 2d 94, 101 & n.3 (Miss. 1998); Kaufman, 754 A.2d at 1197; Everts v. Holtmann, 667 P.2d 1028, 1033 (Or. Ct. App. 1983); Gohler v. Wood, 919 P.2d 561, 566 (Utah 1996); Esser Distributing Co. v. Steidl, 437 N.W.2d 884, 887 (Wis. 1989)).Some state securities laws do require a plaintiff plead actual reliance. For example, Section 517.301 of the Florida Securities Act, Florida’s analogue to Section 10(b) of the Exchange Act, includes reliance as an element. See Camden Asset Mgmt., L.P. v. Sunbeam Corp., 2001 U.S. Dist. LEXIS 11022 (S.D. Fla. July 3, 2001) (“Similarly, for the Florida Securities Act claim, the Eleventh Circuit . . . has found that justifiable reliance is an essential element of a claim under § 517.301 of the Florida Securities Act.”). “Unlike under federal law . . . a presumption of reliance based on a ‘fraud on the market theory’ is unavailable in Florida.”



between the plaintiff and the defendant. For example, the Pennsylvania equivalent to Section 10(b) is Section 1-401 of the Pennsylvania Securities Act.119 Section 1-501 provides a private cause of action for violations of Section 1-401.120 However, Section 1-501 contains a privity requirement.121 In most securities fraud cases, the plaintiffs did not purchase their shares directly from the defendant company, but rather purchased them on the open market. These purchasers would not be able to use statutes requiring privity.122

California’s securities fraud statute – Section 25400(d) of the California Corporations Code which is enforced through Section 25500 – does not require privity.123 However, the statute contains a different obstacle:

The principal limitation of section 25400(d) as a general remedy for securities fraud appears to be the requirement that the party making the misrepresentation be a “broker-dealer or other person selling or offering for sale or purchasing or offering to purchase the security.” To satisfy this requirement, the plaintiff must prove that the defendant was engaged in market activity at the time of the misrepresentations.124

Foreign�Law�Claims Some plaintiffs have pled claims based on foreign law in an attempt to avoid the limitations of Morrison. So far, these claims have not been successful.125

Jurisdiction The threshold issue when pleading foreign law claims is whether the court will have subject matter jurisdiction over the claims. In both Toyota and BP, the plaintiffs sought to establish original jurisdiction over the foreign law claims under the Class Action Fairness Act.126 However, in both cases, the courts applied CAFA’s carve-out for “any class action that solely involves a claim . . . concerning

In re Sahlen& Assoc., Sec. Litig., 773 F. Supp. 342, 371 (S.D. Fla. 1991).119 GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189, 214 (3d Cir. 2001).120 See Kronenberg v. Katz, 872 A.2d 568, 597 (Del. Ch. 2004). 121 See Biggans v. Bache Halsey Stuart Shields, Inc., 638 F.2d 605, 610 (3d Cir. Pa. 1980)

(Section 1-501 “only gives the seller or buyer the right to sue the person purchasing or selling the security.”); Sowell v. Butcher & Singer, Inc., 1987 U.S. Dist. LEXIS 3788 (E.D. Pa. May 12, 1987) (“The Pennsylvania securities statute however, grants a private remedy to a buyer only against a seller and requires strict privity between the parties.”).

122 See also Kaufman v. I-Stat Corp., 165 N.J. 94, 112 (N.J. 2000) (New Jersey does not require reliance, but it does require privity between the plaintiff and defendant, which excludes purchases on the secondary market).

123 Mirkin v. Wasserman, 5 Cal. 4th 1082, 1104 (Cal. 1993).124 Mirkin, at 1123; see also Kamen v. Lindly, 94 Cal. App. 4th 197, 206 (Cal. App. 6th Dist.

20011) (“[W]e conclude that civil liability pursuant to Corporations Code section 25500 applies only to a defendant who is either a person selling or offering to sell or buying or offering to buy a security.”); California Amplifier, Inc. v. RLI Ins. Co., 94 Cal. App. 4th 102, 111-14 (Cal. App. 2d Dist. 2001) (liability under Section 25500 requires that the defendant personally violate Section 25400). The plaintiff need not have purchased from the defendant but must have been “affected by such act or transaction for the damages sustained by the latter as a result of such act or transaction.” Cal. Corp. Code § 25500.

125 See In re Toyota Motor Corp. Secs. Litig., 2011 U.S. Dist. LEXIS 75732, at *17-21 (C.D. Cal. July 7, 2011) (dismissing claims under Japanese law); In re BP P.L.C., 2012 U.S. Dist. LEXIS 17788, at *236-37 (S.D. Tex. Feb. 13, 2012) (dismissing claims under English law).

126 See 28 U.S.C. § 1332(d).

a covered security.”127 CAFA uses the same definition of “covered security” as is used by SLUSA, so the discussion above regarding whether foreign securities are considered covered securities is also relevant here. If Toyota and BP did not have ADR programs in the U.S., their ordinary shares would not have been “listed” on the NYSE and would not be considered “covered securities.” In that situation, the courts would have had original jurisdiction over the foreign law claims.

Even though the Toyota and BP courts held they lacked original jurisdiction over the foreign law claims, they had discretion to exercise supplemental jurisdiction over those claims. Both courts declined to do so.128 In declining jurisdiction, the Toyota court expressly relied on Morrison, holding that the “clear underlying rationale of ” Morrison “is that foreign governments have the right to decide how to regulate their own securities markets.”129 According to the court, “[t]his respect for foreign law would be completely subverted if foreign claims were allowed to be piggybacked into virtually every American securities fraud case, imposing American procedures, requirements, and interpretations likely never contemplated by the drafters of the foreign law.”130

Forum Non Conveniens Even if a U.S. court has jurisdiction over foreign law claims, it may still dismiss those claims under the forum non conveniens doctrine. The forum non conveniens doctrine recognizes a court’s discretion to decline to exercise jurisdiction over a suit if the convenience of the parties and the court and the interests of justice point toward adjudication in another forum.131 A party seeking dismissal on this basis must show that (i) an adequate alternative forum exists and (ii) the balance of the public and private factors favors dismissal.132

The question of forum non conveniens is very fact-specific. Some courts have dismissed foreign claims under the forum non conveniens doctrine. The Third Circuit has held that “[o]nly quite unusual” cases raising foreign securities law claims will be appropriate for adjudication in U.S. courts, because plaintiffs must show both that the U.S. court is “the most appropriate forum” and that a U.S. court “is the most convenient forum, which, particularly for foreign-law claims asserted against foreign entities, is rarely an easy task.”133

127 28 U.S.C. § 1332(d)(9); see Toyota, 2011 U.S. Dist. LEXIS 75732, at *17-18; BP, 2012 U.S. Dist. LEXIS 17788, at *237-38.

128 Toyota, 2011 U.S. Dist. LEXIS 75732, at *19-21; BP, 2012 U.S. Dist. LEXIS 17788, at *238-39.

129 Toyota, 2011 U.S. Dist. LEXIS 75732, at *20. 130 Id. at *20-21131 Koster v. (Am.) Lumbermens Mut. Cas. Co., 330 U.S. 518, 527 (1947); Karim v. Finch

Shipping Co., 265 F.3d 258, 268 (5th Cir. 2001).132 Karim, 265 F.3d at 268-69.133 LaSala v. Bordier Et Cie, 519 F.3d 121, 142-43 (3d Cir. N.J. 2008); see also In re Alcon

S’holder Litig., 719 F. Supp. 2d 263, 275 (S.D.N.Y. 2010) (dismissing shareholder claims



SLUSA Be aware that one court has held (in two separate decisions) that SLUSA bars securities fraud class actions brought under foreign law.134 These decisions are directly contrary to SLUSA’s plain language, which states that it applies only to class actions “based upon the statutory or common law of any State[.]”135 The term “State” is defined as “any State of the United States, District of Columbia, Puerto Rico, the Virgin Islands, or any other possession of the United States.”136 Consistent with the statutory text, the Third Circuit has held that SLUSA does not apply to foreign law claims.137

RICO�Claims Another possibility is the use of federal RICO laws to recover for fraud in connection with the purchase of foreign securities. There are a couple of significant hurdles to this approach.

First, the PSLRA “removed securities fraud as a predicate act under RICO.”138Specifically, the PSLRA modified the RICO statutory text so that it now reads, in part: “no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of [the section prohibiting racketeering activities.]”139 An argument could be made that because fraud in connection with the purchase or sale of a foreign security is no longer actionable under Section 10(b), the RICO carve-out does not apply to fraud in connection with foreign securities. There is some authority to support this argument.140 However, other courts have held that the RICO carve-out applies even when the plaintiff could not bring a federal securities fraud claim.141

on forum non conveniens grounds where “core events, operative facts, applicable law, and associated public policy interests at issue are predominantly” foreign); LaSala v. UBS, AG, 510 F. Supp. 2d 213, 234 (S.D.N.Y. 2007) (dismissing Swiss law claim on forum non conveniens grounds).

134 See LaSala v. UBS, AG, 510 F. Supp. 2d 213, 238 (S.D.N.Y. 2007); LaSala v. Lloyds TSB Bank, 514 F. Supp. 2d 447, 472 (S.D.N.Y. 2007).

135 15 U.S.C. §78bb(f )(1)(A).136 15 U.S.C. §78c(a)(16). 137 See LaSala, 519 F.3d at 142-43 (“This conclusion [that SLUSA does not preempt foreign-

law claims] flows directly from the text of SLUSA, which by its terms only affects claims based upon the laws of a state or territory of the United States.”).

138Anza v. Ideal Steel Supply Corp., 547 U.S. 451, 472 (2006).139 18 U.S.C. § 1964(c); see also In re Enron Corp. Sec., Derivative & ERISA Litig., 284 F.

Supp. 2d 511, 618 (S.D. Tex. 2003) (“Before the RICO Amendment, a plaintiff could allege a private civil RICO claim for securities laws violations sounding in fraud because ‘fraud in the sale of securities’ was listed as a predicate offense.”).

140 See OS Recovery, Inc. v. One Groupe Int’l, Inc., 354 F. Supp. 2d 357, 368-71 (S.D.N.Y. 2005) (holding that RICO claims based on purported aiding and abetting securities violation were not barred by RICO Amendment because they were not actionable by the same plaintiff who brought the RICO claims).

141 See, e.g., MLSMK Inv. Co. v. JP Morgan Chase & Co., 651 F.3d 268, 277 (2d Cir. 2011) (“[T]he PSLRA bars civil RICO claims alleging predicate acts of securities fraud, even where a plaintiff cannot itself pursue a securities fraud action against the defendant.”); Thomas H. Lee Equity Fund V, L.P., v. Mayer Brown, Rowe & Maw LLP, 612 F. Supp. 2d 267, 283 (S.D.N.Y. 2009) (“[T]he RICO Amendment bars claims based on conduct that could be actionable under the securities laws even when the plaintiff, himself, cannot bring a cause of action under the securities laws.”).

Assuming a court were to allow a plaintiff to allege a foreign securities fraud as a racketeering act, a separate issue is whether the RICO claim would be barred as an extraterritorial application of the statute. Since Morrison, multiple courts have held that RICO lacks extraterritorial application.142 Despite these rulings, RICO is presumably still available when there is sufficient conduct in the U.S.143

To, summarize, there may be a narrow path to a successful RICO claim. A successful claim would require a court to hold (1) that acts of foreign securities fraud may be used as predicate racketeering acts (because those acts are no longer actionable as securities fraud) and (2) the conduct at issue has sufficient connection to the U.S. to be considered a domestic application of RICO.

142 See, e.g., Norex Petroleum Ltd. v. Access Industries, Inc., 631 F.3d 29, 33 (2d Cir. 2010); United States v. Philip Morris USA, Inc., 783 F. Supp. 2d 23, 27 (D.D.C. 2011); Cedeno v. Intech Group, Inc., 733 F. Supp. 2d 471, 473-74 (S.D.N.Y. 2010).

143 See Philip Morris, 783 F. Supp. 2d at 29 (noting, and not disagreeing with the premise of, the plaintiffs’ argument that domestic conduct can still give rise to RICO claim even though some conduct also occurs abroad); Picard v. Kohn, 2012 U.S. Dist. LEXIS 22083, at *15 n.3 (S.D.N.Y. 2012) (recognizing that RICO “has its own extraterritorial limitations” and noting, but not deciding, the plaintiff’s argument that the alleged RICO “enterprise has sufficient contacts with the United States to support a RICO claim”).

Section 2: Finding and Tracking Foreign Litigation and Recovery Opportunities


Once the analysis of the available remedies for securities fraud in the U.S. is exhausted, the only available remedy for your fund may be outside the U.S. You may be left in a situation where your fund has purchased ordinary shares of a foreign company on a foreign exchange and, due to Morrison, the only available remedy is an action in that foreign jurisdiction. Given the new realities of global securities litigation after Morrison, public pension funds must adapt to the new challenges of monitoring their portfolios to ensure that opportunities to recover assets in jurisdictions outside the U.S. are not lost. While most of the world’s class action settlements currently occur in the U.S., the global expansion of investor actions continues. Canada, Australia, and Europe have become new hotspots to commence litigation, with Asian countries beginning to implement similar systems. Mexico will allow class actions for the first time in 2012.

Finding and tracking litigation on a global scale is very difficult for U.S. funds to accomplish on their own. Even devoting substantial internal resources to the process may leave significant gaps in monitoring a global portfolio. The identification process is complex and lacks transparency. Moreover, generally, a separate legal and risk analysis must be conducted to help ensure that when a fund joins a foreign action it is reasonable to do so. Considering the complexity and varying set of rules for each country and jurisdiction, investors will need comprehensive coverage of foreign jurisdictions and each jurisdiction’s legal mechanisms for handling investor actions internally. Moreover, unlike the U.S. claims process where investors can remain absent, receive notice of a settlement, and then decide to make a claim or opt-out of the class case, in foreign actions, investors are generally required to “opt-in” to foreign proceedings up front. This “opt-in” process requires affirmative decisions early in the process to join the case in order to recover your share of the proceeds and not leave money on the table. In many cases, investors may be required to make these decisions before a foreign action is even filed. Thus, having a timely mechanism to identify and vet foreign actions is critical.

In addition to timing issues, there are new challenges posed by the funding mechanisms used in foreign jurisdictions. Many jurisdictions do not allow the typical contingency fee arrangements that are used in the U.S. Rather, the cases are funded by groups that are called “litigation funders.” The litigation funders are third parties (typically corporate entities) who finance the cases, register investors, and generally manage the cases. Without such funding, foreign counsel would have to bill clients directly as the case progresses, and the clients would be required to pay substantial attorneys’ fees regardless of the outcome and

recovery (if any) in the case. The litigation funder takes on the risk of loss if the case is not successful (because it is the funder, rather than counsel, that underwrites the litigation’s costs and must pay the attorneys’ fees regardless of the outcome). In return for taking on this risk, the litigation funder earns a percentage of the proceeds if the case is successful, much like contingency fee arrangements in the U.S. In order to offset the risk assumed, litigation funders require a sufficient number of investors to register with them before they will commit to bringing the case. For this reason, a fund will often need to signal its intent to join a foreign action even before the action has been filed, and once the litigation funder closes its group and files the case it is often too late to join the action.

As noted above, funds must confront the difficulties in identifying and tracking foreign actions, evaluating the differences in various overseas legal procedures and substantive laws, and they must do so in a timely fashion before the opt-in period for a foreign action closes. Notwithstanding these challenges, funds may be at risk if they simply ignore foreign actions after Morrison because this inaction could result in the funds being barred from recovery while other funds with identical trading histories attain significant recoveries. This issue raises the question of whether public funds have a fiduciary duty to participate in foreign actions and whether they are breaching that duty by not participating in such actions. The risk of a breach of fiduciary duty is increased when a fund chooses to simply leave money on the table without knowing when investments abroad have been impacted and without analyzing the legal procedures and substantive laws in these foreign jurisdictions. Without the proper tracking and monitoring system in place, the risk that we will leave money on the table is real.

If a U.S. fund wants to ensure it capitalizes on all recoveries it is eligible to receive, in both domestic and foreign actions, it must develop a protocol to stay informed and make prudent decisions relating to its involvement in foreign actions which, unlike domestic cases, require a proactive strategy to ensure timely registration for meritorious cases.

Funds essentially have three options when it comes to monitoring foreign litigation and recovery opportunities: (1) monitor in-house; (2) retain a class action claims monitoring/filing firm; (3) outsource the monitoring of foreign actions and the effects of Morrison to one or more specialist law firms; or retain the services of both a monitoring firm and law firm.



Do-it-Yourself Monitoring For many years, pension funds have monitored U.S. securities class actions, either through their own internal processes, by retaining outside monitoring firms, by retaining an outside law firm or firms to provide this service, or through a combination of the above. For example, some larger funds retain class action monitoring firms to identify losses and then private law firms to provide recommendations upon request when losses hit a certain threshold. With respect to settlements, funds have then generally used their custodian bank or retained private firms to file claim forms once settlement proceeds are available. This type of monitoring tends to be reactive; in other words a case is filed and then the notification procedures begin and the fund decides what, if any, additional action is necessary.

When it comes to monitoring foreign actions post-Morrison, the process becomes far more complex. No centralized resource has, as of yet, been created for the monitoring of international filings and settlements, which is why some funds have chosen to outsource this responsibility to a an entity that has considerable international experience and infrastructure. Alternatively, U.S. funds can undertake these responsibilities in-house, but they should be prepared to devote the appropriate resources to this task to identify applicable foreign actions in a timely manner and thoroughly understand what is involved to successfully monitor exposure to these overseas actions.

Some of the key issues to keep in mind when evaluating foreign actions include:

• Look at the jurisdiction where the action is being brought and evaluate the law in that jurisdiction to identify the potential risks of being involved in a case. In this regard, evaluate the merits of the case in light of the law in that jurisdiction.

• How is the action being funded? Are the funders reliable? What is the percentage fee that the funder is taking from the case?

• What is the process/cost for opting in?

• Who is the foreign counsel and how are they being paid?

• Identify the risks (i.e., to what extent is loser pay covered?).

• What role will your fund play or be allowed to play? No role, active role? How are the decisions made in the case? Do you have any say in anything?

• What is the size of your loss? Did the alleged wrongdoing cause the loss?

• Comply with the appropriate deadlines.

While it is not difficult to identify that a loss has occurred and research company specific news, obtaining information about legal proceedings can be vastly more burdensome depending on the country. Obtaining information online is generally even more difficult, as most countries do not have an online access to court records system comparable to the systems in the U.S.

Class Action Settlement Monitoring/Filing Services A variety of private companies in the U.S. offer claims filing services for institutions. These companies maintain databases of pending, current, and past securities class action or group action lawsuits and settlements, but these are generally for U.S. actions only. For U.S. actions, these providers monitor all class action activity and match those litigations with institutional investors’ historical transaction data.

Other private companies offer shareholder action and settlement monitoring and claims recovery services for institutional investors around the world, including public and private pension funds. They have developed relationships with attorneys in the various countries and are able to identify and evaluate a client’s exposure in cases that are being investigated (pre-filing) as well as pending cases. Thus, these firms (i) monitor securities actions being considered and brought in non-US jurisdictions (“Foreign Actions”); (ii) perform electronic portfolio screening and loss calculations for Foreign Actions; (iii) identify and notify clients of Foreign Actions in which the client has an interest (“Relevant Foreign Actions”); (iv) register the client for Relevant Foreign cases; (v) provide ongoing monitoring of Relevant Foreign Actions where appropriate; (vi) provide full claims recovery services in Relevant Foreign Actions that settle or otherwise result in a recovery; and (v) provide Quarterly reports of monitoring and claims-recovery activities for Foreign Actions.

If a fund decides to utilize a claims filing service to monitor its global portfolio, it is important to do some due diligence to ensure that the provider does in fact have the ability to protect the portfolio internationally. Some questions for funds to ask include:

• Which countries do you provide services for, and what types of services are offered for each?



• What is your process for being notified that foreign class action cases (or their analog) are being brought against companies? How do you receive the information about foreign cases and, typically, when are you notified of the cases?

• What advice and information are you able to provide to your clients regarding participation in foreign cases including the legal process in each jurisdiction?

• How do you handle “opt-in” cases? What services do you provide for such cases?

• Do you work with third parties to provide any of your foreign class action services? If so, which types?

Using a U.S. Law Firm to Monitor and Supervise Foreign Litigation Another option is to use the services of outside law firms to monitor your fund’s investments and alert you to any instances of securities fraud which may have impacted the fund. If a fund chooses not to monitor foreign actions in-house, it may outsource this monitoring, and the effects of Morrison, to one or more specialist law firms. If a fund chooses to do so, it will want to ensure that the law firm is qualified to identify, advise, and register U.S. funds for foreign actions. Similar questions should be asked of a specialist law firm as should be asked of a monitoring service. Importantly, because lawyers who are admitted to practice in the U.S. generally need to affiliate with foreign firms in order to litigate in most foreign jurisdictions, it is important that any specialist law firm have relationships with foreign firms. This global infrastructure is vital to assist in identifying relevant cases, provide information on local laws and procedures, and to help analyze the merits of the cases.

ConclusionThe world of monitoring and tracking securities cases has changed dramatically since Morrison. We must transform our thinking from that of relying on the U.S. securities laws to now developing a prudent process to analyze our options when our shares have been excluded from any U.S. action. We must know when we will not have a remedy under the U.S. securities laws (i.e. shares were purchased on a foreign exchange). We must then look to whether there is a potential state law remedy for these shares. If state law remedies are not available, we must have a process for identifying and analyzing any relevant meritorious foreign actions. When it comes to foreign actions, we need a process in place that allows us to analyze all the factors that go into whether to participate in such an action. We must look at the size of our loss, who is funding the case, what the funding terms are, who the foreign lawyers are, what our potential risks are (i.e. adverse costs, exposure, are we subject to third party claims), what role we will need to play in the litigation, and what happens if the case is unsuccessful. These are just some of the steps we must go through in analyzing our best course of action once it is determined that we have no remedy in the U.S. The question becomes not if we are going to monitor and track foreign cases, but rather what is the best way to do so.

Section 3: The Legal Landscape in Ten Foreign Jurisdictions


When evaluating foreign actions, it is important to consider the jurisdiction in which the claim would be brought since the legal landscape can have a significant impact on the course the case takes, as well as the outcome of the case itself. There is not currently a central system for obtaining information about class actions in various foreign jurisdictions, so the NAPPA Morrison Working Group researched and put together information about ten different countries so that each NAPPA member would have a resource for basic class action information. The countries examined and outlined below are: Australia, Belgium, Canada, Denmark, France, Germany, Japan, the Netherlands, South Korea, and the United Kingdom. The group came together and decided to start with ten of the largest foreign exchanges. Within each of these jurisdictions, we focused on the following main areas:

• Loser pay model• Opt-in vs. opt-out• Class actions (extraterritorial jurisdiction)• Funding the litigation- contingent fee arrangements• Fraud on the market theory• Pleading standards

Along with these main issues, we focused in general on the issues that we should be aware of in bringing securities fraud cases in these jurisdictions, including the regulatory landscape.

AUSTRALIA

OverviewClass actions have been available in the Federal Court of Australia since March 1992.144 Australia was one of the first countries outside of the United States to introduce comprehensive class action regimes, which was achieved through the enactment of Section IVA (“Representative Proceeding Act” or the “Act”) of the Federal Court of Australia Act 1976, on March 4, 1992.145 In passing the Representative Proceeding Act, the Australian Parliament hoped to provide access to the courts to those in the community who had been effectively denied legal redress because of the high cost of taking action. The general philosophy underpinning this policy goal of modern class action regimes, commonly known as the judicial economy goal, is thus the efficient use of finite judicial resources.146 Group actions may also be conducted in the Supreme Courts of most states and territories pursuant to Part 4A to the Supreme Court Act of 1986. But each state’s implementation may vary.

144 Brief of the Government of The Commonwealth of Australia as Amicus Curiae in Support of the Defendant-Appellees attached to Australian Government Submission to SEC, February 18, 2011 at 17. http://www.sec.gov/comments/4-617/4617-34.pdf

145 Jane Caruana and Vince Morabito, Australian Unions—the Unknown Class Action Protagonists, Civil Justice Quarterly, Issue 4, 2011 at 382.

146 Id. at 384.

According to Luke Green of ISS:

Per the Securities Class Action Services database, Australia had seen approximately 45 securities class action cases pursued since 2003 with 16 reaching a settlement thus far. Just 8 of those suits produced a little under $500 million in settlement funds. While shareholder class actions progressed at an excruciatingly slow pace leading up to the early 2000’s, today Australia is second only to Canada in terms of total settlement dollars, number of settlements, and number of suits for non-U.S. shareholder class actions.147

According to NERA, the first securities class action was filed in 1993. The second, and first successful one, was filed in 1999. About one per year was filed thereafter until 2004, at which point the number increased steadily through 2009 when six were filed.148

Basics of Filing a Claim and LitigationA proceeding under the Act may be commenced where: (a) 7 or more persons have claims against the same person; and (b) the claims of all those persons are in respect of, or arise out of, the same, similar or related circumstances; and (c) the claims of all those persons give rise to a substantial common issue of law or fact.149

147 Luke Green, RiskMetrics Group, Exploring Securities Class Actions in Australia, http://blog.issgovernance.com/slw/2011/04/australia-securities-class-action-update-29-million-settlement-against-fincorp-investments.html

148 NERA Economic Consulting, Trends in Australian Securities Class Actions: 1 January1993-31 December 2009, at 3. http://www.nera.com/nera-files/PUB_Recent_Trends_Australia_0510.pdf

149 Federal Court of Australia Act of 1976, (“Act”) Part IVA. Sec. 33C, http://www.austlii.edu.au/au/legis/cth/consol_act/fcoaa1976249/s33c.html



The Act states that it is irrelevant: (a) whether or not the relief sought: (i) is, or includes, equitable relief; or (ii) consists of, or includes, damages; or (iii) includes claims for damages that would require individual assessment; or (iv) is the same for each person represented; and (b) whether or not the proceeding: (i) is concerned with separate contracts or transactions between the respondent in the proceeding and individual group members; or (ii) involves separate acts or omissions of the respondent done or omitted to be done in relation to individual group members.

Unlike the U.S. system, no initial class certification is required in Australia. The burden is thus placed on the respondent to show that it is not appropriate for the claims of the plaintiffs to be pursued by way of the class action.150 The absence of initial classification in Australia is balanced by the presence of a “loser pays” cost rule. Another difference is that, although Rule 23(b)(3) of the U.S. Federal Rules of Civil Procedure requires that the issues common to the class must “predominate” over the individual issues, the Australian statute requires only that there exist a “substantial common issue of law or fact.”151

To start the process, (1) an application commencing a representative proceeding, or a document filed in support of such an application, must, in addition to any other matters required to be included: (a) describe or otherwise identify the group members to whom the proceeding relates; (b) specify the nature of the claims made on behalf of the group members and the relief claimed; and (c) specify the questions of law or fact common to the claims of the group members. (2) In describing or otherwise identifying group members for the purposes of subsection (1), it is not necessary to name, or specify the number of, the group members.152A group member may file an application to substitute another member as a representative party upon a showing that the current representative is not able to adequately represent the interest of the group members.153 Trials are without a jury unless the Court orders otherwise.154

Loser Pay ModelThe representative party, who brings the action, has the formal responsibility for running the case and for complying with any orders made by the court and is liable for any costs awarded in favor of the class action defendant.155 Costs may not be awarded against absent group members.156

150 Australian Government Submission to SEC, February 18, 2011, at 10.151 Id.152 Act, Sec. 33H, http://www.austlii.edu.au/au/legis/cth/consol_act/fcoaa1976249/

s33h.html153 Act, Sec. 33Y, http://www.austlii.edu.au/au/legis/cth/consol_act/fcoaa1976249/

s33t.html154 Act, Sec 29.155 Jane Caruana and Vince Morabito at 387.156 Act, Sec. 43.

Opt-in vs. Opt-outConsent is not required to be a group member in a representative proceeding.157 A member may opt-out by written notice by a date fixed by the Court. The hearing of the representative proceeding may not be commenced before that date.158 In reality, because of the “loser pays” rule and the lack of contingent fees, most cases are “opt-in” sub-classes created by commercial litigation funders who solicit members before filing the action. See below.

Class Actions (Extraterritorial Jurisdiction)Australia filed both an amicus brief in Morrison and a comment letter for the Study on Extraterritorial Private Rights of Action conducted by the SEC pursuant to Section 929Y of the Dodd-Frank Wall Street Reform and Consumer Protection Act.159 In those submissions, the Government of the Commonwealth, not the judiciary, took the position that Morrison is the proper interpretation of the reach of securities anti-fraud law based on issues of comity and the strict statutory interpretation of the U.S. securities laws. Australia pointed out that laws differ in Australia with different incentives and awards. For instance, in Australia the loser pays. It also pointed out that there were well developed remedies available in Australia for U.S. investors to use. So, it is clear that Australia was not taking a hard line approach to extraterritoriality. Rather, they point out in their brief that, in fact, Australia explicitly provides for extraterritoriality under the “conduct and effects test” in their own law:

E. The Extraterritorial Jurisdictional Scope of Australia’s Legislative Regime Is Expressly Provided For

The market misconduct provisions in Part 7.10 of the Corporations Act apply to certain acts or omissions outside of Australia, but only when they are tied to conduct and effects in Australia. These include:

• manipulating a financial market in Australia;

• false trading on a financial market in Australia;

• dissemination of information about illegal transactions on a financial market in Australia; and

• making materially false or misleading statements that are likely to have the effect of increasing, reducing or maintaining the prices on a financial market in Australia.(footnote - See Corporations Act, §§1041B, 1041C, 1041D, 1041E; see especially §1041E(1)(b)(iii).)

157 Act, Sec. 33E, http://www.austlii.edu.au/au/legis/cth/consol_act/fcoaa1976249/s33e.html

158 Act, Sec 33J, http://www.austlii.edu.au/au/legis/cth/consol_act/fcoaa1976249/s33j.html

159 Australian Government Submission to SEC ,February 18, 2011 attaching Brief of the Government of The Commonwealth of Australia as Amicus Curiae in Support of the Defendant-Appellees. http://www.sec.gov/comments/4-617/4617-34.pdf



The ASIC Act also has provisions that reflect an Australia-focused approach to extraterritoriality. Section 12AC(1) extends various of the Act’s prohibitions to conduct engaged in outside of Australia by: “(a) bodies corporate incorporated or carrying on business within Australia; or (b) Australian citizens; or (c) persons ordinarily resident within Australia.” Thus, the Corporations Act and the ASIC Act differ from the approach taken by the U.S. Congress in the Securities Exchange Act of 1934, which was silent on the issue of extraterritorial application.160

Thus, Australia’s securities laws have extraterritorial effect.

Funding the litigation- contingent fee arrangementsAustralia prohibits contingency fees, though it permits “no-win no-fee” arrangements, and in some jurisdictions permits an “uplift” up to 25 percent.161 As a result of this lack of a fee incentive for the lawyers, and the threat of costs, very few securities suits were initially brought since the passage of the group action device.

As in the U.S., historically, litigation funding was prohibited in Australia as encouraging litigation (maintenance) and profiting from it (champerty).162 That all began to change with laws abolishing it as a crime or as a tort in the states and territories. In 1995, insolvency practitioners were allowed to contract for the funding of lawsuits, if the contract was characterized as property of the insolvent company---such as actions by the insolvent company against former officers and directors.163 The funder paid the costs of litigation (which included attorneys’ fees) and accepted the risk of paying the defendants’ costs in the event of a loss, and indemnified the plaintiff for the same. Fees ran between one-and two-thirds.164

In Campbells Cash and Carry Pty Limited v Fostif Pty Ltd.,165 Australia’s highest court considered the legality of litigation funding for the first time. The High Court held that litigation funding was not an abuse of process or contrary to public policy — existing doctrines of abuse of process and the courts’ ability to protect their processes would be sufficient to deal with a funder conducting themselves in a manner ‘inimical to the due administration of justice.166 The Court did not decide the position for those states where legislation had not abolished maintenance

160 Brief of the Government of The Commonwealth of Australia as Amicus Curiae in Support of the Defendant-Appellees attached to Australian Government Submission to SEC, February 18, 2011 at 11-12. http://www.sec.gov/comments/4-617/4617-34.pdf

161 “The push to reform class action procedure in Australia: evolution or revolution,” Melbourne University Law Review, Vol. 32 No. 3, December 2008.

162 Michael Legg, Louisa Travers, Edmond Park, and Nicholas Turner, Litigation Funding in Australia, University of New South Wales Faculty of Law Research Series, 2010 -12 at 3. http://law.bepress.com/unswwps/flrps10/art12 or HTML: http://www.austlii.edu.au/au/journals/UNSWLRS/2010/12.html

163 Id. at 4.164 Id. at 4.165 Campbells Cash and Carry Pty Limited v Fostif Pty Ltd, (2006) 229 CLR 386166 Legg, Travers, Park and Turner at 6.

and champerty as crimes and torts (Western Australia, Queensland, Tasmania and the Northern Territory).167

Subsequent to Campbells there have been a host of issues thrown at the funders by respondents (the defendants in Australia). Most commercial litigation funders, like IMF (Australia) Ltd., have chosen a “class action” model that is, in reality, an Opt-In procedure:

Commercial litigation funders, such as IMF, agree to meet the claimant’s legal costs and disbursements in the litigation and pay any adverse costs orders which might be made in the event the litigation fails. The funder will also provide any security for costs which the claimant may be ordered to make. In return, the claimant agrees to reimburse the funder’s direct outlays on the litigation out of any settlement or damages award recovered by the claimant and to pay the funder an agreed percentage of the balance remaining after reimbursement. The funder’s return is in all cases contingent on the claimant’s success in the litigation.168

The closed model, opt-in, class action addresses the concern that the class action regime as an “opt-out” process would inevitably result in “free riders,” i.e. claimants who chose not to sign a funding agreement but who would benefit from the outcome of the class action without having to contribute towards its cost.169 In Multiplex Funds Management Ltd v P Dawson Nominees Pty. Ltd.,170 the Full Federal Court of Australia rejected respondents’ attack on the “closed class” and permitted the use of a “limited group” or “closed class” that existed at the time the suit was commenced and provided that members could opt-out. The “sub-group” would be identified as those who entered into the funding agreement.171

Other evolving issues include privilege, security for costs, and regulation of management schemes. It is likely more regulation will develop to protect investors and consumers.172

Fraud on the Market TheoryIn Australia, the courts are yet to rule on whether fraud on the market or a similar theory applies to the proof of causation in shareholder claims. However, there have now been several significant settlements in Australia in shareholder class actions. In each of those cases, the shareholder claimants have sought to argue a version of the “fraud on the market” theory. While the concept of “fraud on the market” is still a matter for judicial determination in Australia, its legislative framework appears to be flexible enough to accommodate the theory. The settlement of actions which have contended for the theory seems to be

167 Id. at 7.168 IMF (Australia) Ltd, Funding Criteria for Class Actions, at 2, retrieved on 4/25/2008,

http://www.imf.com.au/pdf/FundingCriteriaforClassActions.pdf169 Id. at 2.170 Multiplex Funds Management Ltd v P Dawson Nominees Pty Ltd (2007) 164 FCR 275171 Legg, Travers, Park and Turner at 14 -16.172 Id. 17-43.



consistent with a degree of acceptance by practitioners within Australia.173

Causes of Action in Securities LitigationMost securities class actions in Australia are heard by the Federal Court of Australia, which has jurisdiction over Commonwealth legislation, including legislation that serves as the basis for most securities class action claims. Such actions typically arise out of the Corporations Act 2001, the Competition and Consumer Act 2010 (prior to January 2011 was the Trade Practices Act 1974), and/or the Australian Securities and Investments Commission Act 2001.174

More specifically, many claims allege that the defendant violated the disclosure rules imposed on listed companies and/or they allege violations of the Corporations Act 2001 prohibition on deceptive conduct in connection with securities. Additionally, allegations often include breaches of fiduciary trust.175

Chapter 7.10 of the Corporations Act contains prohibitions relating to insider trading, market manipulations, and various other types of fraudulent and misleading conduct. Prohibited conduct includes: market manipulation (s.1041A); false trading and market rigging (creating a false or misleading appearance of active trading ) (s.1041B); artificially maintaining trading price (s.1041C); dissemination of information about illegal transactions (s.1041D); false or misleading statements (s.1041E); inducing persons to deal (s.1041F); dishonest conduct (s.1042G); and misleading or deceptive conduct (s.1041H). With the exception of misleading or deceptive conduct (s.1041H), for which there is civil liability only, these types of conduct are all criminal offences and breaches are subject to both criminal prosecutions and civil actions. The Corporations Act also provides statutory backing for the continuous disclosure requirements imposed on listed entities by securities markets (s.674) and enables courts to order compensation in relation to breaches (s.1317HA).176

Australia laid out the availability of the private rights of action of investors in its amicus brief in Morrison:

Civil remedies that may apply to a claim of the type alleged in this case are found in Part 7.10. In that Part, § 1041I makes available private civil actions for those injured by (i) false and misleading conduct (§ 1041E); (ii) improperly inducing someone to deal (§ 1041F); (iii) dishonest conduct (§1041G); or (iv) misleading or deceptive conduct (§1041H).

173 Slater & Gordon, Shareholder Class Actions in Australia, current state of play, retrieved on April 25, 2012. http://www.slatergordon.com.au/files/editor_upload/File/flyers/Shareholder%20Class%20Actions.pdf

174 Id. at 1.1175 Luke Green, supra.176 Australian Government Submission to SEC, February 18, 2011, at 9-10.

A contravention of the continuous disclosure requirements in Chapter 6CA of the Corporations Act that are applicable to listed entities may also give rise to civil damages. By §674, such entities are required to comply with the continuous disclosure requirements in the listing rules of the financial markets on which their securities are traded…. Section 1317HA empowers a court to order the payment of compensation for damages suffered as a result of a contravention of § 674.

The ASIC Act also provides a private civil action in § 12GF for those injured by: (i) unconscionable conduct (§§ 12CA-CC); (ii) misleading or deceptive conduct (§ 12DA); or (iii) false or misleading representations (§ 12DB).

Civil actions under the Corporations Act and the ASIC Act can be brought in a federal court or the courts of an Australian state or territory having jurisdiction over the defendant(s). Appellate review is available in each jurisdiction.177

Regulatory Environment for Securities LitigationThe Australian Securities and Investments Commission (ASIC) is responsible for overseeing corporations and market integrity, including disclosure standards and consumer protection. ASIC regulates Australian companies, financial markets, financial services organizations, and professionals who deal and advise on investments, superannuation (i.e., retirement pension), insurance, deposit taking, and consumer credit. ASIC is also responsible for registering and supervising the operation of managed investment schemes.178

The level of foreign investment in Australia increased by A$136 billion (US$136 billion) in 2009 to reach A$1,898 billion (US$1.9 trillion). Portfolio investment accounted for A$1,098 billion (US$1,098 billion or 58%), direct investment for A$436 billion (US$436 billion or 23%), other investment liabilities for A$285 billion (US$285 billion or 15%), and financial derivatives for A$79 billion (US$79 billion or 4%). Of the portfolio investment liabilities, debt securities accounted for A$729 billion (US$729 billion or 66%) and equity securities for A$369 billion (US$369 billion or 34%).

The leading investor countries in 2009 by level of investment were the United States, with A$514 billion (US$514 billion or 27%), the United Kingdom with A$499 billion (US$499 billion or 26%), Japan with A$102 billion (US$102 billion or 5%), Hong Kong Special Administrative Region with A$43 billion (US$43 billion or 2%), the

177 Brief of the Government of The Commonwealth of Australia as Amicus Curiae in Support of the Defendant-Appellees attached to Australian Government Submission to SEC, February 18, 2011 at 15-16. http://www.sec.gov/comments/4-617/4617-34.pdf

178 U.S. Department of State, Bureau of Economic, Energy and Business Affairs, 2011 Investment Climate Statement—Australia (March 2011), available at http://www.state.gov/e/eb/rls/othr/ics/2011/157234.htm



Netherlands with A$43 billion (US$43 billion or 2%), and Germany with A$38 billion (US$38 billion or 2%).179

According to the Australian government in its amicus brief in Morrison, it welcomes and embraces the new class action regime:

Senior ASIC officials have also welcomed the creation of this type of action. In 2005, ASIC’s Deputy Chairman explained that “[t]he increase in shareholder vigilance, coupled with the emergence of shareholder class actions, means that ASIC is better able to focus on its surveillance and enforcement functions while shareholders play a proactive role in protecting their interests....”(footnote omitted)180

The ASIC is also, purportedly, very active in vindicating investor rights:

Finally, ASIC, using its statutory power to institute civil actions on behalf of injured investors, has brought class actions in circumstances where it believed that the victims lacked the financial resources to pursue the case themselves. To date, ASIC has brought at least nine securities class actions on behalf of victims.42 were filed in 2006, five were filed in 2007, eight were filed in 2008, and at least nine were filed in 2009. In the still-pending Westpoint related financial products cases, ASIC has already recovered for investors some $A100 million of the $A388 million invested.(footnotes omitted.)181

179 Id.180 Amicus Brief at 18.181 Id. at 20-21

BELGIUM

Class actions (extraterritorial jurisdiction)Civil procedure in Belgium does not currently permit class actions and Belgium’s legislature has not yet enacted any statutes establishing a separate legal construct enabling class actions to be filed.182 However, several draft bills have been or are currently circulating among Belgium’s legislative branches and within academic circles, which seek to establish the legal right to commence a class action, but its progress is slow.183 Although there appears to be a political majority in favor of a law establishing a class action procedure, which has the support of many consumer associations, there are certain organizations, like the federal business organization VBO/FEB, which are opposed to the introduction of a class action procedure based on the claim that class actions would unduly increase the burden of litigation.184 It is uncertain whether the Belgian Parliament will proceed on its own initiative to establish class actions or wait for the potential legislation that is currently being discussed on the European level. Thus far, all attempts to enact a class action procedure in Belgium have failed and, according to Evelyn Terryn, “this issue does not appear to be at the top of the Prime Minister’s [Elio Di Rupo] list.”185 Nevertheless, others believe that it is just a matter of time before Belgium establishes the right to commence class actions given the wave of class action law sweeping through Europe.186

The principle hurdles to bringing class action claims in Belgium are Articles 17 and 18 of the Belgian Code of Civil Procedure (“BCCP”), which require that every party to a proceeding in a Belgian court have a personal interest and capacity in the claims asserted in order to have standing to prosecute those claims. The requirement that a plaintiff have a personal interest in the claims means that class actions are excluded under Belgian law because one plaintiff cannot file a claim on behalf of others. This

182 Matthias E. Strome & Evelyne Terryn, Belgian Report on Class Actions, 3 (2007) available at http://www.law.stanford.edu/display/images/dynamic/events_media/Belgium_National_Report.pdf

183 Proposal of 16 August 2007, Doc Parl 52/0109/001; Proposal of 22 February 2008, Doc. Parl. 52/0872/001; Proposal of 17 March 2008, Doc Parl 52/0978/001; Proposal of 29 May 2009, Doc Parl 52/2019/001.

184 The European Lawyer-Class Actions, available at http://www.europeanlawyer.co.uk/referencebooks_26_485.html.

185 See also International Comparative Legal Guide Series, Class & Group Actions: Belgium (2009).

186 Allen & Overy, Belgium: Class & Group Actions 2010, at 2-3 (Dec. 2009) available at http://www.allenovery.com/AOWeb/binaries/53521.pdf; see also, International Bar Association website stating “it has become obvious that Belgium is not going to be able to duck the wave of class action legislation which is likely to engulf Europe in one way or another” available at http://www.ibanet.org/Article/Detail.aspx?ArticleUid=114c5468-279b-42f8-8ac6-a65dac9d3b05 (visited on March 26, 2012).



principle also applies to corporate entities (a corporation cannot file a claim on behalf of its constituent members).

Thus, claims introduced by consumer associations with the aim of protecting the general interest of claimants lack standing under Belgian law.

Importantly, there are statutory exceptions to Articles 17 and 18 which allow certain associations to collectively act before the court. For example, the following associations can seek injunctions:

• Associations defending consumers’ interests with legal personality can request a cease and desist order with respect to unfair trade practices (Art. 98 of the Law on Trade Practices); and

• Associations defending the professional interests of members of a specific profession (e.g., lawyers, doctors, architects…).187

However, actions brought under this statute, especially for misleading practices, are rare primarily due to lack of funding and the fact that plaintiffs cannot seek damages.188

Another potential avenue for redress for defrauded investors is Belgium’s criminal courts. Under Belgian law, any party that has suffered damages due to a defendant’s tortious conduct – which also constitutes a criminal wrong – can join any criminal proceeding instituted by a government prosecutor. Defrauded investors can appear (i.e. join) the criminal proceeding as “civil parties”189 and have their claims (for damages, restitution, etc.) adjudicated by the criminal court.190

These exceptions and alternative forms of redress, however, do not give entitlement to bring actions for damages before the courts.191 Thus, any of the recent cases in Belgium involving multiple claimants represented by an association are not traditional class actions, but are more aptly described as mass (or collective) actions, in which each claimant has a demonstrable interest in the claims asserted and is appearing by proxy through the association.

Despite the failure of the Belgian legislature to pass a law establishing a class action procedure, group actions in some form or another have become an increasing feature of high profile litigations in Belgium, particularly for financial institutions. There is no procedural rule prohibiting a consumer or investment group from banding together the claims of a few hundred or thousand individual claimants 187 See The 1991 Act on Unfair Commercial Practices and Consumer Protection Act. 188 Matthias E. Strome & Evelyne Terryn, Belgian Report on Class Action, at 10-11 (2007).189 Denis Waelbroeck, Kelly Cherrette, and Aurelie Garth, Belgium Report, 4 (2004), available

at http://ec.europa.eu/competition/antitrust/actionsdamages/national_reports/belgium_en.pdf.

190 Matthias E. Strome & Evelyne Terryn, Belgian Report on Class Actions, at 3 (2007).191 See March 1898 Act on professional organizations and the 5 December 1968 Act on

unions.

and representing them by proxy. These group actions do not violate Articles 17 and 18 because each claimant is itself either personally appearing or represented by proxy.

Examples of group actions include the Lernout & Hauspie (“L&H”) and Citibank Belgium cases. A group action was commenced in 2001 against L&H (a speech technology company) in Belgium in the wake of its worldwide accounting fraud. The L&H case was brought by an investor protection association known as Société Anonyme Deminor (“Deminor”),192 which represented 13,000 claimants who suffered $500 million in damages as the result of L&H’s fraud. The limitations of the group were acutely demonstrated when Deminor, who had accepted claimants from September 2001 to April 2007, was forced to stop accepting additional claimants because each claim had to be individually analyzed and the service costs had become significant.193 Interestingly, in the L&H case 5,000 victims filed their “civil party” claims in a criminal proceeding against L&H’s founders and other defendants, as opposed to joining the group action. The court convicted 8 of the 21 defendants in September 2010. The “civil party” claims are still pending.

In the Citibank Belgium case, Deminor commenced a group action against Citibank Belgium in 2008 in the Brussels Commercial Court as a result of the collapse of Lehman Brothers. Citibank Belgium had sold financial products issued and guaranteed by Lehman Brothers. After Lehman’s collapse, 4,100 Citibank Belgium clients lost their savings (approximately 130 million euro). Within 15 months, Deminor announced a settlement whereby investors received 68 percent of the face value of the Lehman notes. Notably, the Belgian government filed a criminal complaint against Citibank Belgium and secured a conviction based on the misrepresentations made to investors. 63 victimized investors of Citibank Belgium filed “civil party” claims with the Criminal Court. Instead of taking the aforementioned settlement offer, the Criminal Court imposed fines on Citibank Belgium and awarded full (100 percent) compensation to all 63 investors.

The Dutch Brussels Bar In an attempt to temporarily fill the legislative void with respect to class actions, on October 1, 2009, the Dutch speaking Brussels Bar (Nederlandse Orde van Advocaten bij de Balie te Brussel, or NOAB) implemented a series of optional rules aimed at governing attorneys who bring “class actions” in Belgium.194 Despite the fact that

192 Deminor is firm that specializes in minority shareholder claims and is a “leading European company focusing on services to investors in Continental-European companies.” See http://www.deminor.com/.

193 Allen & Overy, Belgium: Class & Group Actions 2010, at 3 (Dec. 2009).194 As reported by the International Bar Association available at http://www.ibanet.org/Article/

Detail.aspx?ArticleUid=114c5468-279b-42f8-8ac6-a65dac9d3b05



class actions do not exist in Belgium yet, these rules –in summary— provide the following:

• Lawyers who wish to act as a class counsel on future matters must request to be included on a separate list of class counsel, which will be drawn up by the NOAB Council; and

• Members of this list are allowed to publicize their membership on their website, letterhead, etc.; and

• If a member of the list wishes to act as counsel in a class action, he or she must contact the President of the Bar and share his/her views on both the feasibility of the proceedings and their probable outcome, and the proposed fee calculation method; and

• The lawyer must also provide to the Bar President a description of (i) the management of the case, both from an administrative and an organizational point of view, (ii) the publicity to attract members to the class, and (iii) the guaranteed independence of the lawyer.

In addition, the Bar President may grant class counsel the authorization:

• To structure his/her fees in such a way that the success fee arrangement applies to a significant fraction of the fees, provided however that the legal prohibition of a “no cure – no pay” system is observed, and provided that the class counsel can demonstrate the ability to fund the conduct of the contemplated class action; and

• To publicize his/her representation of the class with a view to attracting more class members, provided that the publicity is not misleading and that it observes the standards of the dignity of the profession.

NOAB made it clear that these rules were optional and that they would eventually be obsolete after the Belgian Parliament enacts a comprehensive class action system.

Loser Pay ModelThe law on the recovery of attorneys’ fees and expenses provides that the losing party must be ordered to pay a nominal amount called ‘procedural indemnity’ (i.e. a lump sum intended to cover a part of the lawyers’ fees). The amount of the procedural indemnity, with a maximum of EUR 30,000, depends upon the value of the claim and of the parties’ financial situation.

Opt-in vs. Opt OutThere have been a number of litigation cases in Belgium in which consumer or investor groups, comprising a few hundred to several thousand victims, have participated as claimants in relation to specific actions by one or a few related defendants. However, none of these proceedings

can be characterized as true class action proceedings because essentially they do nothing more than bundle a number of claims into one action. Significantly, in these proceedings, each claimant is itself either personally present or represented by a specially appointed proxy. Therefore, these group actions in Belgium are akin to the “opt-in” actions in the United States.

Funding the Litigation—Contingent Fee ArrangementsBelgian rules of civil procedure prohibit a lawyer from being paid solely on the outcome of a case.195 Strict no-win, no-fee agreements are prohibited.196 Success fee agreements, however, are permitted and can be added to a lawyer’s main fees.197

Fraud on the Market TheoryBelgium does not recognize the fraud on the market theory.198

Jurisdiction and Pleading StandardsJurisdictionThe civil court system in Belgium has courts of general jurisdiction and specialized courts including a Commercial Court. Under Article 573 of the Judicial Code, the Commercial Court hears disputes between parties to commercial transactions which do not fall under the general jurisdiction of the justice of the peace or under the power of the police courts. The Commercial Court has jurisdiction over any actions involving the purchase or sale of securities. The Citibank Belgium group action was commenced in the Commercial Court, as well as the group action instituted against Fortis, as a result of alleged misrepresentations in the Fortis-ABN AMRO transaction in 2008.

Pleading StandardsWith respect to causation, the Prospectus Act of 16 June 2006 provides a rebuttable presumption of a causal link between the absence of information or misleading or inaccurate information in a prospectus, and the damage incurred by investors when such absence or misleading or inaccurate information is likely to have a positive influence on the purchase price of the financial instrument or to create a positive feeling in the market.

195 See Article 446ter of the Code of Civil Procedure. 196 Mathias Reimann, Cost and Fee Allocation in Civil Procedure, 84 (2012).197 Id.198 See Warlop v. Lernout, 05-Civ.-12058 (PBS) (D. Mass. Feb. 12, 2007) (in dismissing

action and deeming Belgium an adequate forum, the court recognized that “[t]here are much more difficult hurdles for plaintiffs in Belgium, who do not have the class action mechanism or the ability to use a ‘fraud on the market’ theory to assist in recovery.”).



Government RegulationOn April 1, 2011, Belgium implemented a new regulatory structure to supervise its financial system.199 Known as the “Twin Peaks model,” Belgium’s financial system is now regulated by two entities: the National Bank of Belgium and the Financial Services and Markets Authority (“FSMA”), formerly known as the CBFA (Commissie voor het Bank, Financie- en Assurantiewezen/Commission Bancaire, Financière et des Assurances). The FSMA is responsible for:

supervising the financial markets and listed companies, authorizing and supervising certain categories of financial institutions, overseeing compliance by financial intermediaries with codes of conduct and supervising the marketing of investment products to the general public, as well as for the ‘social supervision’ of supplementary pensions. The Belgian government has also tasked the FSMA with contributing to the financial education of savers and investors.200

Under Belgian law, listed companies must provide the markets with up-to-date information about the state of their affairs. Such information must be provided periodically in the annual or interim statements or, as a rule, without delay each time the company is aware of information of a sufficiently precise nature and which is likely to have a significant effect on the prices of its listed financial instruments. In addition, a prospectus must be published when securities are offered to the public or admitted to trading on a regulated market. The FSMA is responsible for the supervision of the compliance by issuers of these regulations.

199 See FSMA website available at http://www.fsma.be/en/About%20FSMA/Powers.aspx (visited on March 26, 2012).

200 See http://www.fsma.be/en/About%20FSMA/Powers.aspx.

CANADA

Securities Class Actions Exist in Many Canadian ProvincesThere is no nationwide securities class action system in Canada akin to the federal securities laws in the United States. Matters involving securities in Canada have long been subject to the provincial legislative jurisdiction over “property and civil rights within the province.”201 The Superior Courts in the provinces have inherent and general jurisdiction in Canada and it is these courts that deal with securities types of claims.202 Also, legislation dealing with the pursuit of class proceedings has been enacted by the provinces themselves.

All but one of the Canadian provinces has a class action procedure and generally the various provinces provide for opt-out classes.203 With the exception of Quebec, legislation specifically dealing with class proceedings has really only been in effect since the mid-1990s and, thus, securities class actions are a relatively new practice area. The recent amendments to the Ontario Securities Act, R.S.O. 1990, c S.5 in December 2005 (allowing for secondary market misrepresentation claims often referred to as Bill 198 cases) has done much to fuel this practice area.

Securities class actions are being filed mostly in Ontario, British Columbia, Quebec and Saskatchewan, but Ontario is, by far, the most active jurisdiction due to the above-noted amendments. This activity is also not surprising because the main exchange, the Toronto Stock Exchange (the “TSX”), is located in Ontario.204

The Ontario class action legislation is the Class Proceedings Act, 1992, S.O. 1992, c. 6, s. 12. As the number of securities class action cases increase, the Canadian courts, particularly the Ontario courts, are starting to develop basic legal principles to deal with these matters.

201 See Reference Re: Securities Act, 2011 SCC 66 (Can.).202 The Federal Court in Canada is a statutory court and its jurisdiction is limited generally by

the Federal Court Act and other federal legislation that confers jurisdiction on that court. Generally the Federal Court deals with such matters as claims against the Federal Crown, intellectual property, maritime and admiralty claims and national security.

203 Prince Edward Island does not have any class action statute. However, although there is no legislation regarding class actions in PEI, the courts may have jurisdiction to certify class actions under existing rules of practice related to representative proceedings.

204 The major equity exchange in Canada is the Toronto Stock Exchange (TSX). The other exchanges are: (i) Montreal Exchange – an options exchange (co-owner of the Boston Options Exchange); (ii) ICE Futures Canada – the Winnipeg Commodity Exchange; (iii) Nasdaq Canada; and (iv) CNQ – Canada’s newest stock exchange for trading equities of emerging companies.



Because the Ontario cases tend to be the “dog wagging the tail,” this memorandum focuses primarily on Ontario law.205 The law and procedures in most provinces are generally the same as Ontario but there are notable differences.

Carriage Motions (Lead Plaintiff/Lead Counsel Motions)One such difference is that Quebec is a first to file jurisdiction and, therefore, the first plaintiff to file a class action in that jurisdiction will be the lead plaintiff or, as referred to in Canada, the representative plaintiff. By contrast, Ontario courts entertain fulsome motions, called “carriage motions,” when multiple class actions are filed on the same matter. In these motions, the court will analyze many factors to determine which plaintiff, as well as which law firm, should be appointed as the representative plaintiff and class counsel, respectively.206

Unlike the U.S., there is no uniform test for determining who should be the lead plaintiff and lead counsel in Ontario. In the Sino-Forest case, the court engaged in merits-based analyses and considered the characteristics of the plaintiffs and how each firm alleged its complaint. Specifically, the court considered the definition of class membership, the theory of the case, the causes of action, joinder of defendants and prospects of certification to assess which firm’s theory it preferred. The size of the plaintiffs’ losses was considered but the court clearly did not view the fact that one shareholder had the largest loss as a dispositive fact. While the court did think appointing institutional investors as lead plaintiffs would be beneficial, it also favored a group that included both institutional investors and individuals.

Extra-Territorial Reach of Each Province’s Statute and New Protocols to Address Concerns with the Pendency of Actions in Multiple JurisdictionsThe courts seem to broadly interpret the territorial application of their laws. In particular, based on the language of the Ontario Securities Act, Ontario courts have adopted a test that considers whether there are substantial connections to Ontario as opposed to a Morrison type of test that focuses on the exchange where the securities were purchased.207

205 By way of background, the Ontario class action mechanism is similar to that in the U.S. with several exceptions: (i) an Ontario court does not consider merits when assessing whether to certify a class; (ii) there is no requirement that common questions must predominate over individual questions (it is sufficient if there are common questions that can be resolved through a class action); and (iii) there is no jury trial.

206 See, e.g., Smith v. Sino-Forest Corp., [2012] O.J. No. 88 (Ont. Sup.Ct.) (a recent ruling on a carriage motion by an Ontario court considering applications by both Canadian and U.S. institutional and individual movants).

207 See, e.g., Abdula v. Canadian Solar Inc. et al., [2011] O.J. No. 4067 (Ont. Sup. Ct.) (holding that the Ontario Securities Act applies to a company that chooses to be incorporated in Canada, has its principal office in Ontario, and carries on business in Ontario), affirmed on appeal, [2012], ONCA211 (Ont. C.A.). Also see, Van Breda v. Village Resorts Ltd., [2010] O.J. No. 402 (Ont. C. A.) the most recent Court of Appeal decision on jurisdiction and forum non-convenience.

Generally, Canadian firms are not filing cases simply if a company is listed on the TSX. Rather, they focus on cases where the company in question has a significant tie to Canada. In fact, they have filed cases where the company in question is not even listed on a Canadian exchange but is effectively a Canadian company.208 One such example involved Canadian Solar Inc., a company registered in Canada but operated in China, whose shares traded only on the NASDAQ.209

Because there is no nationwide practice and each province is broadly interpreting the territorial application of its laws, Canada is currently struggling with the problem of class cases being filed in multiple jurisdictions, each purporting to represent the same class members.210 This problem occurs both when there are cases filed in multiple provinces and also when there are cases pending in both Canada and the U.S.

In practice, at the settlement stage, U.S. and Canadian law firms have cooperated to avoid problems with settling a case on behalf of a class that may include residents of the other country. However, problems can arise when there is a lack of cooperation. For example, in one case, the U.S. court approved a settlement of a class action involving Canadian residents but the Canadian court refused to enforce the U.S. class action judgment on grounds that the U.S. court failed to meet the due process and procedural fairness requirements for notice to absent class members.211 In the securities arena, there is currently a battle regarding the IMAX securities case, which has delayed the U.S. settlement.212 Apparently, there was no cooperation between the U.S. and Canadian counsel and the U.S. parties reached a settlement that included many of the same class members as the Ontario case. Specifically, both the U.S. and the Ontario actions purported to include persons worldwide (including in Canada) who purchased shares of IMAX, a Canadian company, listed on NASDAQ. The U.S. settlement required an order from the Ontario court seeking to exclude from the definition of the Canadian case all persons who do not opt out of the U.S. settlement.Canadian counsel believe that the U.S. settlement is inadequate and are challenging such efforts.213

208 Since there are few examples where Canadian companies do not trade on a Canadian exchange, this is not likely to occur frequently.

209 See Abdula v. Canadian Solar et al., [2011] O.J. No. 4067 (Ont. Sup. Ct.).210 See Tiboni v. Merck Frosst Canada Ltd., [2008] O.J. No. 2996 (Ont. Sup. Ct.), and

Wuttunee v. Merck Frosst Canada Ltd., [2008] S.J. No. 101 (Q.B.), rev’d [2009] S.J. NO. 179 (Sask. C. A.). Also see exclusive FORUM SELECTION IN NATIONAL CLASS ACTIONS: A COMMON ISSUES APPROACH, by Scott Maidment, Canadian Class Action Review Vol. 5 No. 2 August 2009, (Irwin Law, Canada).

211 One such case was Currie v. McDonald’s Restaurants of Canada Ltd. [2005] O.J. No. 506 (Ont. C. A.).

212 See In re IMAX Corp. Sec. Litig., Case No. 1:06-cv-6128 (S.D.N.Y.). 213 There is much debate about whether Canadian or U.S. law is better for plaintiffs. Several

key differences are that (i) Ontario law caps an issuer’s potential liability in a secondary market fraud case (i.e., a § 10(b) open market type case) at the greater of $1 million or 5% of the issuer’s market capitalization; (ii) Ontario law requires that a plaintiff be granted leave to proceed with a secondary market class action; (iii) among other tests for



Because of these difficulties, there have been some efforts to set up class action protocols for cross-border class actions.214 On August 14, 2011, the Council of the Canadian Bar Association (i) approved as best practices the Canadian Judicial Protocol for the management of Multi-Jurisdictional Class Actions; and (ii) endorsed the ABA “Protocol on Court-to-Court Communications in Canada—U.S. Cross-Border Class Actions” and “Notice Protocol: Coordinating Notice(s) to the class(es) in Multijurisdictional Proceedings.” On August 8-9, 2011, the American Bar Association issued a resolution adopting as best practices the Protocol on Court-to-Court Communications in Canada-U.S. Cross-Border Class Actions and Notice Protocol: Coordinating Notice(s) to the Class(es) in Multijurisdictional Class Proceedings (together, the Protocols).

With respect to Canada-U.S. Cross Border cases, these protocols provide (i) standardized mechanisms to notify counsel, parties and the courts of overlapping actions, and to conduct settlement proceedings with the goal of ensuring that notice to class members is provided in a meaningful way that will be understood by all affected persons in the differing jurisdictions (the “notice protocol”); and (ii) that courts should communicate with other courts where there is commonality among substantive or procedural issues (a “communication protocol”). The objective of these protocols is to ensure that U.S.-Canada cross-border class actions be prosecuted in a coordinated and efficient manner. However, these protocols are non-binding. Before a court applies these protocols (with or without modifications), counsel must be given notice and an opportunity to be heard regarding what sections of the protocol to apply.

Monitoring of Canadian Cases and Potential Scope of ClassUnlike the U.S., there are no services tracking all Canadian securities class action filings. This is in part because there is no nationwide scheme, the court filing systems are not all electronic, and because there are far fewer cases brought in Canada. There is a nationwide class action database held

certification of a class action, common issues need not predominate over individual issues; it is sufficient that the common issues would materially advance the litigation (iv) Ontario follows a “loser-pay” rule for costs awards, discussed below; (v) U.S. law requires the plaintiff to prove “scienter” whereas Ontario generally does not for misrepresentations made in core documents (such as annual or interim financial statements)—but the Ontario statute does provide for a due diligence defense; (vi) there is a higher pleading standard in the U.S.; (vii) the recent Ontario decision in Sharma v. Timminco Ltd., [2012] O.J. No. 719, imposes a rigorous standards for plaintiffs for the statute of limitations in open market cases; and (viii) discovery is generally more limited in Canada.

214 There are several groups attempting to tackle the issues including (i) the ABA Canada/U.S. Class Action Protocol Project; (ii) the Canadian Bar Association National Task Force; and (iii) the International Bar Association’s Task Force on International Procedures and Protocols for Class Actions.

by the Canadian Bar Association which can be viewed at http://www.cba.org/ClassActions/main/gate/index/about.aspx; however, it is a pilot project that is not mandatory in all jurisdictions. It is now mandatory in Ontario. The website states that “The database will list all class actions filed in Canada after January 1, 2007 that are sent to the CBA. Once posted, a class action proceeding will remain on the database unless and until it is dismissed as a class action by the court. Starting March 1, 2007, counsel will be able, if they wish, to request that proceedings filed prior to January 1, 2007, be posted on the CBA website. These archived class actions will be posted as soon as time permits.”

Moreover, Canadian securities class actions are increasing in number so one would anticipate increased tracking of securities cases. The National Economic Research Associates Inc. (NERA) issued its annual report on Canadian Securities cases and reported that 15 securities class actions were filed in Canada last year, the most ever in a calendar year, and there were 45 cases pending at the end of 2011.

Loser Pays Provisions ApplyWhile there are some differences between the provincial class legislation, for the most part, Canadian provinces are loser pays jurisdictions. Under this “loser-pay” system, the courts have considerable discretion in determining the costs award, and will only assess an award based on what is “fair and reasonable” for that person to pay.215 The Courts of Justice Act in Ontario provides:

Subject to the provisions of an Act or rules of court, the costs of and incidental to a proceeding or a step in a proceeding are in the discretion of the court, and the court may determine by whom and to what extent costs shall be paid.216

In addition to the “fair and reasonable” requirement, Ontario recently revised its Rules of Civil Procedure to provide that the court must consider proportionality when making a costs award:

In applying these rules, the court shall make orders and give directions that are proportionate to the importance and complexity of the issues, and to the amount involved, in the proceeding.217

215 There are several groups attempting to tackle the issues including (i) the ABA Canada/U.S. Class Action Protocol Project; (ii) the Canadian Bar Association National Task Force; and (iii) the International Bar Association’s Task Force on International Procedures and Protocols for Class Actions.

216 R.S.O. 1990, c. S.5, s. 131(1).217 Ontario Rules of Civil Procedure 1.4(1.1).



Although the system is known as “loser-pays,” it is very rare for the court to order the unsuccessful party to pay the full amount of the successful party’s costs. Rather, the courts award costs on different scales: partial indemnity, substantial indemnity, and full indemnity.218 Typically, courts award costs based on partial indemnity, which generally ranges from 40 to 75 percent of the actual, reasonable fees.219 Substantial and full indemnity awards are rare and are reserved for situations in which the unsuccessful party conducted itself in a manner deserving of sanctions.220 Substantial indemnity awards are typically 90 percent of the actual legal costs, and full indemnity is 100 percent of the actual costs, as the name implies.221 The wide discretion of the courts has left litigants unable to predict their exposure to adverse costs awards.

In an effort to encourage settlement, Ontario has implemented special cost rules related to offers of settlement.222 The rules provide that when a plaintiff makes an offer to settle at least seven days before trial, and the offer is not withdrawn before the commencement of the trial, and the defendant does not accept the offer, then the plaintiff is entitled to partial indemnity costs to the date the offer to settle was made and substantial indemnity costs from the date the offer was made, as long as the plaintiff obtains a judgment as favorable, or more favorable, than the offer to settle. The rule also provides that if a defendant makes such an offer and the plaintiff obtains a judgment as favorable as, or less favorable than, the defendant’s offer, then the plaintiff is entitled to partial indemnity costs up to the date of the offer and the defendant is entitled to partial indemnity costs from the date of the offer. In both instances, the court has discretion to change the costs award.

Such awards are not inconsequential. In Kerr v. Danier Leather Inc.,223 the court awarded costs in excess of $1 million against the plaintiff. In a more recent decision McCracken v. Canadian National Rail,224 the plaintiff was awarded over $750,000 for costs of the certification motion.225 Funding agreements are, thus, an integral part of Ontario cases.

218 Erik S. Knutsen, The Cost of Costs: The Unfortunate Deterrence of Everyday Civil Litigation in Canada, 116, 36 Queen’s L.J. (2010), at 122.

219 Id. at 123.220 Id. at 124.214 Id.215 Ontario Rules of Civil Procedure 49.10.223 2007 SCC 44 (Can.)224 [2010] O.J. No. 4650 (Can. Ont. Sup. Ct.).225 As of May 31, 2012, the matter is currently before the Court of Appeal for Ontario.

Funding Of CasesEvery jurisdiction in Canada permits lawyers to be paid by a contingency fee.226 However, given the limitation on damages as well as the possibility of owing significant costs under the loser-pay model, contingency arrangements are not as common in Canada as they are in the United States. There are two main sources of funding for class proceedings in Ontario: (i) indemnities given by class counsel; and (ii) funding supplied by funders. Several provinces, most notably Ontario, have an approved non-private quasi-public funding source, which is quite unique by American standards. The Ontario source is administered through the Class Proceedings Committee (CPC). The CPC provides financial support for disbursements and indemnity against costs, through the “Class Proceedings Fund.”

In 1992, the Law Society Amendment Act established the CPC and the Class Proceedings Fund to provide financial support to class action plaintiffs for disbursements in Ontario Class Actions.227 The fund was first established with a $500,000 grant from the Law Foundation of Ontario, which is a grant-making organization that promotions and enhances justice for Ontarians. The CPC’s current sources of funding are (i) a levy of 10 percent of any awards or settlements in favor of plaintiffs in funded proceedings; and (ii) a return of any funded disbursements after settlement or award. Details about how to apply are on the website http://www.lawfoundation.on.ca/howtoapply.php. Plaintiffs’ applications (including oral submissions) are confidential. The CPC may seek the applicants’ permission to request written submissions from defendants. Understandably, such permission is almost never given. Any defense submission is not confidential and plaintiffs may receive a copy of it.

If accepted: (i) there are reporting requirements (i.e., need to provide advance notice of motions and copies of documents filed with the court); (ii) all costs including loser paid costs are covered; and (iii) 10 percent of recovery is paid back to the Fund.

The CPC states that it determines whether applicants will receive funding based upon a number of considerations including “the merits of the plaintiff ’s case, the extent to which the issue in the proceeding affects the public interest, the plaintiff ’s efforts to raise funds, the likelihood of certification and the amount of money in the Fund.”228 The CPC summarizes its financials as well as statistics regarding applications, such as total number of hearings held and applications approved, in its annual reports.229

226 Erik S. Knutsen & Janet Walker, Litigation Funding and Costs in Canada, 7 (July 2009).227 See http://www.lawfoundation.on.ca/cpcabout.php.228 Currently at least one defense attorney is on the committee evaluating whether to fund a

case under this scheme.229 See http://www.lawfoundation.on.ca/cpcreport.php.



Ontario law firms are also increasingly using private funders as well. In Dugal v. Manulife Financial Corporation, Justice Strathy held that a foreign litigation funding company could indemnify the plaintiffs from their exposure to a potential adverse cost award in exchange for a cut of any money recovered from litigation.230 In the order, the Court noted that litigation funding was a necessity given the loser-pay model in effect in Ontario:

The grim reality is that no person in their right mind would accept the role of representative plaintiff if he or she were at risk of losing everything they own. No one, no matter how altruistic, would risk such a loss over a modest claim.231

However, in approving the agreement, it was important to the court that CFI had not “stirred up, incited or provoked the litigation,” and that CFI was charging a “reasonable” (7 percent) commission with a “reasonable” commission cap ($5 million pre-trial and $10 million thereafter).232 Additionally, the funding agreement left control of the litigation in the hands of the representative plaintiff as long as the funder received appropriate information about the progress of the case.233

The decision in Dugal has not yet been reconsidered in Ontario; however, case law demonstrates that class counsel are beginning to look for third party financing as a result of the decision.234 Courts in other Canadian provinces recently approved funding agreements, but did not articulate the reasons for the decisions.235

One recent action where plaintiff sought private funding is in the 2011-filed case involving Sino-Forest Company. In the carriage motion under the Class Proceedings Act, four law firms were competing for carriage of the class action. Several of the firms indicated that they were seeking funding from various private groups such as (i) CFI—http://www.claimsfunding.eu/; and (ii) Bridgepoint Financial Services, a Canadian litigation lender—http://bpfin.com.236 It should be noted that both firms indicated 230 See Dugal v. Manulife Financial Corp.,[2011] O.J. No. 1239 (Ont. Sup. Ct.) (provides

outline of terms of retention agreements). 231 Id. at ¶ 28.232 Id.233 Id.234 In an earlier case, a court considered whether to allow third party financing for class actions.

See In Metzler Investment GMBH v. Gildan Activewear Inc., [2009] O.J. No. 3315 (Can. Ont. Sup. Ct.). Justice Leith found that although the court had broad discretion under s.12 of the CPA that discretion should not be exercised when the action had not yet been certified and class members had not had an opportunity to present their views over the funding agreement. In Dugal, Justice Strathy found that there was jurisdiction under s.12 to approve this funding and the plaintiffs sought to address the concerns raised by Leitch J. by giving notice of the agreement to a representative cross-section of the class (notices were sent to 25 funds that held the largest number of shares including several of Canada’s largest public pension funds).

235 See Hobshawn v. Atco Gas and Pipelines Ltd. (May 14, 2009), Action 0101-04999 (Alta. Q.B.) (approving a third party funding agreement in the Alberta Court of Queen’s Bench); MacQueen v. Sydney Steel Corporation (October 19, 2010), Action 218010 (N.S.S.C.) (approving a third party funding agreement in the Supreme Court of Nova Scotia).

236 BridgePoint Financial Services is a Toronto based litigation lender, and their website indicates that BridgePoint offers unique and proprietary financial solutions for class and mass tort actions including: indemnification for the representative plaintiff in class proceedings; disbursement/working capital financing for counsel and; financing legal fees.

that if the funding arrangements were refused, they would either proceed with the litigation and indemnify the plaintiffs or apply to the CPC.237

A key difference between obtaining third party funding and funding through the Class Proceedings Fund is that the third party funding must be approved by the court. If an application is made to the Class Proceeding Fund, the court does not need to approve the arrangement, as it is made pursuant to the legislation set out above. In Dugal, Justice Strathy considered the specific facts of the case to determine whether or not the agreement was “champertous” and therefore illegal under Ontario law. Justice Strathy found no evidence that the CFI stirred up, incited or provoked the litigation, and found that the agreement was therefore not champertous. However, Strathy J. did require further information on two issues regarding the arrangement: (i) further evidence regarding the capacity of CFI to satisfy any costs award that may be made; and (ii) further information about the reasonable controls on the provision of information to the funder. Once this further evidence was given, Justice Strathy approved the agreement.238

The advantage to obtaining third party funding is that the amount paid as a levy can be negotiated. With the CPC Fund, the levy is always 10 percent. In Dugal, the plaintiffs were able to negotiate an agreement whereby CFI would receive 7 percent of any money recovered.

Hiring CounselSince the introduction of class proceedings legislation, contingency fees arrangements have become legal and more common.239 That is, attorneys can advance all fees and expenses in a class action and plaintiffs are not liable for any payment of fees and reimbursement of expenses if there is no recovery in the case.

Usually, Ontario firms will enter into a retention agreement which provides for contingent fees ranging between 20 to 30 percent in any class action or for a specific multiplier. Retention agreements are generally the same for all types of class actions including securities class actions. The attorneys must then file a motion for attorneys’ fees to receive payment from a settlement.

Canadian courts have not established a specific standard for assessing the reasonableness of an award of fees and reimbursement of expenses in class actions.240 For example, some courts focus on lodestar (the amount 237 See Smith v. Sino-Forest Corp., [2012] O.J. No. 88 (Can. Ont. Sup. Ct.).238 There are numerous concerns raised about funders and funding agreements. For example,

for obvious reasons, the Chamber of Commerce is strongly opposed to funding agreements. Concerns have also been raised where funders have any veto or say in prosecution of the cases. Interestingly, many banks that are occasionally named as defendants in securities cases have arms that provide private funding. For example, Credit Suisse had a litigation finance business, which was spun off as Parabellum Capital in January 2012.

239 See, e.g., the Solicitors Act, R.S.O. 1990, c S.15 and Ont. Reg. 195/04.240 Courts apply the same standard for all class actions, securities or other.



obtained by multiplying the number of hours spent by a reasonable hourly rate). Others will simply consider the reasonableness of the percentage award. Some will consider both. However, courts have considered the same type of factors as U.S. courts have considered, such as (i) the results achieved; (ii) the risks undertaken; (iii) the time expended; (iv) the complexity of the matter; (v) the degree of responsibility assumed by counsel; (vi) the importance of the matter to the client; (vii) the quality and skill of counsel; (viii) the ability of the class to pay; (ix) the client and class expectation; (x) avoiding inconsistencies with awards in similar cases in other jurisdictions; and (xi) fees in similar cases. When applying a percentage method, courts typically do scale back the percentage awarded. A 2007 report indicates that the average multiplier is 2.5.241

In practice, there have been a number of cases where the Ontario firms have filed with the assistance of U.S. law firms. In some instances, the cooperation stems primarily from the fact that the U.S firm’s client is stepping forward. In other instances, the U.S. firms have offered special expertise in the case.

There have been a number of Ontario decisions addressing the question of how U.S. firms are to be paid and the issue is still in flux. U.S. attorney participation is not prohibited, but the courts will scrutinize the specific relationship to assess whether it is permissible and to ensure that the U.S. firm does not have a proprietary interest in the litigation, per se, that could be construed as champerty, maintenance, or impermissible fee splitting.242 The Ontario courts seem amenable to participation by U.S. firms where the U.S. firm has some tangible benefit to offer separate and apart from simply running or funding the Ontario action. The developing law seems to provide that (i) a consulting role is acceptable (e.g., providing general strategic advice or investigative services) —but one court noted that certain fees for such consulting may have to be paid by Canadian counsel, not out of the class award, since they can be viewed as “education”; (ii) command and control must lie with the Canadian attorneys and the U.S. counsel cannot control the litigation or act as de facto class counsel; (iii) the U.S. attorneys cannot underwrite the litigation; (iv) there is no fee splitting, so there is an issue about sharing fees on a percentage basis; and (v) the clients must be fully apprised of the relationship. In one instance, the court awarded costs against the U.S. firm.

241 See Benjamin Alarie, Rethinking the Approval of Class Counsel’s Fees in Ontario Class Actions, The Canadian Class Action Review, Vol. 4, No. 1 (July 2007), pp. 15-46. In McCarthy v. Canadian Red Cross Society, [2007] O.J. No. 2314 (Can. Ont. Sup. Ct.), there were multiple actions in various provinces and plaintiffs have to obtain orders approving both the settlement and fees in each province. The award was paid directly from the defendant so the analysis was slightly different but the fee represented a multiplier of approximately 3.75. The Ontario court refused to grant an award of $75,000 to the representative plaintiff for his time and expense in the case.

242 Sharma v. Timminco Ltd., [2009] O.J. No. 4511 (Can. Ont. Sup. Ct.). Also see, Poulin v. Ford Motor Co. of Canada [2006] O.J. No. 4625 (Can. Ont. Sup. Ct.).

DENMARK

Trends in Securities LitigationThe Danish Class Action Act became effective on January 1, 2008, and provides for both opt-in and opt-out class actions.243 There have been, however, few reported actions brought under this law. On January 26, 2012, Jyske Bank, Denmark’s second-biggest bank, announced that it had made a provision of US$40 million for potential liability after the Danish High Court allowed investors in the bank’s Jyske Invest Hedge Markedsneutral fund to bring a class-action lawsuit.244 The action against Jyske Bank is only the second class action ever filed in Denmark – the first class action was against Bank Trelleborg A/S.245

The relative dearth of class actions law is likely due to the fact there are not significant incentives for investors or their lawyers to bring a class action. In opt-in class actions, the class representative may be required to pay legal costs as a security, as well additional legal costs up to the amount they stand to recover. Moreover, Danish lawyers cannot be awarded a percentage of the class’s recovery in a successful class action but instead may only charge their ordinary billable rate. In opt-out class actions, only public bodies, such as the Danish Consumer Ombudsman, may serve as class representatives.

The class action Act requires a “sunset” review of the regime after three years. Such a review takes place this year (2012).

Opt-In and Representative Actions Under the Danish Class Action ActAfter significant debate, and a recommendation by the Standing Committee on Procedural Law (Retsplejeradet), the Danish Parliament enacted the Danish Class Action Act in February 2007. Effective as of January 1, 2008, this law provides for two types of class actions: (1) an opt-in class action, and (2) a representative action (i.e., an opt-out class action). Class actions may only be brought when the class members have “uniform claims” based on the “same factual circumstances” as well as the “same legal basis,” and Denmark must be the proper legal venue for all asserted claims. The court must determine that a class action is the best way of examining the claims. Finally, court approval is required for settlement.

243 Administration of Justice Act, pt. 23, Act No. 181. Feb. 28, 2007 (Den.) (in force Jan. 1, 2008).

244 Reuters, “Jyske Bank profit hit by $40 mln hedge fund provision,” Jan. 26, 2012, available at http://www.reuters.com/article/2012/01/26/jyskebank-idUSL5E8CQ2NH20120126.

245 Anna Molin, “Jyske Bank Hit By Class Action Lawsuit In Hedge Fund Case,” Dow Jones Newswires, Nov. 26, 2010.



Private parties may bring opt-in class actions. After receiving notice, parties that want to opt-in must register with the court. The representative may be changed at least half of members of the group make the request. The parties may be required to pay money to register as a security as well as pay additional legal costs up to the amount that they might be able to recover.

In opt-out class actions, only a public entity, such as the Danish Consumer Ombudsman, may serve as a class representative. This requirement reflects the fact that an opt-out class action was believed, by at least some, to be foreign to Danish legal tradition. In addition, the amount of each member’s claim must typically be no more than 2,000 Danish kronor or 270 euros as opt-out proceedings are only considered appropriate if the claims are “unmarketable.” Whether proceedings will take place on an opt-in or opt-out basis lies in the judge’s discretion.

According to the legislative history, examples of cases that might be suitable for a class action include:

• homes with roof materials that crumbled;

• hemophiliacs that had been treated with HIV-infected blood in public hospitals;

• compensation claims for flight tickets;

• unlawful fees collected by banks;

• cases on unlawful price trusts;

• a prospectus with material omissions; and

• a large number of subscribers of a telecommunications company claiming that the company collected rates that were higher than authorized.

Interestingly, the Danish Standing Committee on Procedural Law that recommended the law acknowledged the possibility that a small minority of class members might not become aware of an opt-out notice, but concluded that this issue did not give rise to due process concerns.

Attorneys’ Fees, Costs, and Third Party FundingIn Denmark, under the general rules of the Administration of Justice Act on legal costs, the losing party is normally ordered to pay at least a proportion of the costs which a party has to pay to his lawyer. This rule applies to opt-in class actions. Moreover, the court may require the representative to provide security for legal costs as well as pay outstanding costs not covered by the group. In class actions, if there is a risk of very high legal costs, security is generally required.

The maximum costs to be covered by group members are decided at the beginning of proceedings. In opt-out class actions, however, participating members cannot be ordered to provide security for legal costs and thus only be ordered to pay legal costs that do not exceed the limits of the amount payable to the group member as a result of the action. Finally, it is illegal for lawyers to agree to fix their fees as a certain portion of the damages awarded. While third party funding is permitted, such funding may have tax implications or be questionable if made with an illegal purpose.

Danish Securities LawsThe OMX Nordic Exchange Copenhagen is the Danish center for trade of listed securities such as stock, bonds, notes, derivatives and money market instruments. The OMX Nordic Exchange Copenhagen is a part of OMX Nordic Exchange, which consists of two divisions: (1) OMX Exchanges, which operates seven stock exchanges in the Nordic and Baltic countries (including the OMX Nordic Exchange Copenhagen), and (2) OMX Technology, which develops and markets systems for financial transactions that are used by the OMX Exchanges and other stock exchanges. Securities listed at the OMX Nordic Exchange Copenhagen are carried out electronically and registered with the VP Securities Services (Værdipapircentralen).

The most important securities laws are (1) the Danish Securities Trading Act (“Værdipapirhandelsloven”), (2) the Danish Financial Businesses Act (“LovomFinansielVirksomhed”) and the Rules Governing Securities Listing on the Nasdaq OMX Copenhagen.246 These acts and rules are supplemented by derivative regulation issued through a number of executive orders setting forth detailed provisions on particular subjects such as issuers’ disclosure duties. In addition, the Danish Financial Supervisory Authority (“the DFSA”) has issued a number of guidelines on the interpretation of the executive orders. Finally, the EU Transparency Directive provides the framework for issuers of securities admitted to trading on a regulated market within a member state (listed companies).

246 Portions of this section are from http://www.mwblaw.dk/Doing%20Business%20in%20Denmark/Securities%20law.aspx



FRANCE

OverviewClass actions do not presently exist under French law. While there has been significant debate and discussion in France over the implementation of class actions, such a system has not yet been accepted by the French government. There are, however, more restrictive methods for bringing representative actions that are discussed below.

Under French law, there is a “contestation” over a right rule (“principe du contradictoire”) that allows each person involved in a lawsuit to appear in court and be heard. Those who oppose the introduction of an opt-out class action system argue that this principle would be violated if one claimant was able to represent the interests of a class.247 Another important principle in French law that does not support class actions is that “no one shall plead by proxy” (“Nul ne plaide par procureur”) meaning that no one may represent the interests of other persons. Each plaintiff must set forth his own individual claims.248

The law does allow for a more restrictive form of collective representation called “action en representation conjointe,” or a common representation action.249 French law allows for consumer associations with governmental approval to take action in the collective interest of consumers. The approval must be granted by the ministry of Economy and Finance. Even approved consumer associations may only bring collective actions when several consumers have sustained individual injuries caused by the same actor and have a “common origin.”250 French law allows for investor actions to be brought as common representation actions. Article L. 452-2 of the Monetary and Financial code allows for an opt-in action “stipulating that if ‘in their capacity as investors, several . . . persons have suffered individual damage having a common origin though the actions of the same person . . . [a properly declared investor defense association] may, if it has been instructed by at least two of the investors concerned, sue for damages . . . on behalf 247 Veronique Magnier, Class Actions, Group Litigation & Other Forms of Collective Litigation

Protocol for National Reports: France, 3 (2007), http://globalclassactions.stanford.edu/sites/default/files/documents/France_National_Report.pdf

248 Dominique de Combles de Nayves and Benoit Javaux, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 83 (2011), www.iclg.co.uk/khadmin/Publications/pdf/3976.pdf.

249 David H. Kistenbroker, Alyx S. Pattison, Patrick M. Smith, Recent Developments in Global Securities Litigation, 1904 PLI Corp. 607 at 13 (2011).

250 CODE MONÉTAIRE ET FINANCIER [C.M.F.] arts. L. 452-1 & L. 452-2 (Fr.) available at http://195.83.177.9/code/liste.phtml?lang=uk&c=25&r=899.; Dominique de Combles de Nayves and Benoit Javaux, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 83 (2011), www.iclg.co.uk/khadmin/Publications/pdf/3976.pdf.

of those investors.”251 In order to qualify as an approved association for investor claims, the association must have an express purpose of representing investors in matters relating to investment products.

When bringing a collective action on behalf of investors, investor associations are prohibited from soliciting via television, radio or personalized letters. If an approved association brings an investor action, the judge may allow for the group to solicit powers of attorney from the investors to allow them to act on their behalf. If approved by the judge, the association may pursue advertising though the above-listed means.252

If a common representation action is unsuccessful, the consumers or investors lose their right to sue on those claims. If the defendant is found liable, the award is divided among the injured claimants “since the only purpose of these actions is to get compensation for their individual injuries.”253

Loser Pay ModelFrance operates under the “loser pay” rule. Under French law, costs of litigation “shall be borne by the losing party.”254 Throughout the course of the action, each party is responsible for its own attorney and expert fees. Under Article 700 of the French Code of Civil Procedure (CPC), the judge may order the losing party to pay for at least part of the successful party’s legal fees. In making this determination, the court will consider the financial resources of the losing party. Courts very rarely require individual plaintiffs or consumer associations to pay such fees when they have been unsuccessful in a case against a corporation. In practice, the “loser pays” rule is usually only applied to corporate defendants.255

251 David H. Kistenbroker, Alyx S. Pattison, Patrick M. Smith, Recent Developments in Global Securities Litigation, 1904 PLI Corp. 607 at 13 (2011) citing to CODE MONÉTAIRE ET FINANCIER [C.M.F.] arts. L. 452-1 & L. 452-2 (Fr.) available at http://195.83.177.9/code/liste.phtml?lang=uk&c=25&r=899.

252 Veronique Magnier, Class Actions, Group Litigation & Other Forms of Collective Litigation Protocol for National Reports: France, 10 (2007)

253 Veronique Magnier, Class Actions, Group Litigation & Other Forms of Collective Litigation Protocol for National Reports: France, 11 (2007)

254 Dominique de Combles de Nayves and Benoit Javaux, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 88 (2011), www.iclg.co.uk/khadmin/Publications/pdf/3976.pdf




Opt-in vs. Opt-outCommon representation actions require individual plaintiffs to opt in. In order for an association to bring an action on behalf of consumers or investors, each plaintiff must authorize the representation in writing.256

As noted in the amicus brief filed by the European Aeronautic Defense & Space Co., N.V., Alstom SA, Lagardere Group SCA, Thales SA, Technip SA and Vivendi SA in Morrison, French opponents of an opt-out class action system argue that French constitutional principles of individual notice, consent, and party autonomy would be violated if absent class members were bound by an opt-out class judgment.257

JurisdictionArticle 42 of the French Code of Civil Procedure allows defendants to be sued where they are domiciled.258 Thus, an action against a French company may be brought in France. As an alternative, defendants may also be sued where a contract is performed or a tort is committed.259 The French Code Civile, under Articles 14 and 15, includes a specific provision for foreigners bringing actions in France. These Articles allow jurisdiction before French courts when a French citizen or company is a party to the action – whether plaintiff or defendant.260

Funding the Litigation- Contingent Fee ArrangementsContingency fees are illegal in France. The traditional form of payment to lawyers is based on either a fixed sum or an hourly rate basis. There are rare circumstances where complementary or “success” fees are allowed. Such fees are strictly monitored by French judges and can only represent a small portion of the total fees.261

Third-party funding is another possible method available in French litigation. Although Article 11.3 of the National Bar Association Rules requires that a lawyer be paid only by his client or client’s agent, it is possible that third-party funding would be permitted if there is a contract with the plaintiff governing the funding and the plaintiff ultimately makes payments to his lawyers.262


257 “Brief for the European Aeronautic Defense & Space Co., N.V., Alstom SA, Lagardere Group SCA, Thales SA, Technip SA and Vivendi SA,” Morrison v. National Australia Bank Limited, 2010 WL 719336 (U.S.), 28 (U.S.,2010).

258 CODE DE PROCEDURE CIVILE {C. PROC. CIV.} art.42 (Fr.).259 C. PROC. CIV. art.46 (Fr.).260 C. CIV. art. 14 (Fr.); C. CIV. art. 15 (Fr.); Andrew L. Strauss, Beyond National Law: The

Neglected Role of the International Law of Personal Jurisdiction in Domestic Courts, 36 Harv. Int’l L.J. 373, 388 (1995).

261 Veronique Magnier, Class Actions, Group Litigation & Other Forms of Collective Litigation Protocol for National Reports: France, 21 (2007).

262 Article 11.3 of the National Bar Association Rules; Dominique de Combles de Nayves and Benoit Javaux, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 89 (2011), www.iclg.co.uk/khadmin/Publications/pdf/3976.pdf

Fraud on the market theoryFrench law requires plaintiffs seeking damages in securities cases to establish individual reliance.263 Therefore, the theory of fraud on the market does not exist in France.

Pleading StandardsFrench pleading standards require that claims contain more factual support than the general pleading standards in America, and are more analogous to the pleading requirements for a Section 10(b) case under the Private Securities Litigation Reform Act. The emphasis is on informing the defendant of the claims against him. In France, the statement of claim must make a “expos des moyens” or a “statement of the methods by which the claims will be proved.”264 This statement should include any facts on which the plaintiff relies in stating his claim. A properly pled statement of claim must also include copies of all written evidence referred to by plaintiff. French pleading rules also state that the statement of the claim “vaut conclusions,” or “merits conclusions,” meaning that the allegations in the claim must be conclusive.265

Causes of Action in Securities LitigationFrench shareholders may bring private securities actions. As “parties civiles,” shareholders may bring or join criminal claims for securities violations. When the trial for criminal securities violations concludes, the judgment will include an award for both criminal and civil liability.266

As discussed above, there is no French equivalent to the American class action where private parties can bring securities claims on an aggregate basis. Because of the limitations on securities actions, including the lack of a fraud on the market theory and the risk of an unsuccessful party’s liability of legal fees, it is difficult for plaintiffs to bring individual securities actions. Such restrictions incentivize plaintiffs to allow regulatory bodies to bring their claims to first establish violation before any private action is brought.267

263 “Brief for the European Aeronautic Defense & Space Co., N.V., Alstom SA, Lagardere Group SCA, Thales SA, Technip SA and Vivendi SA,” Morrison v. National Australia Bank Limited, 2010 WL 719336 (U.S.), 28 (U.S.,2010) citing Société Eurodirect Marketing v. Pfeiffer, no. 03-20600 (Cass. Com. Nov. 22, 2005).

264 Peter F. Schlosser, Lectures on Civil-Law Litigation Systems and American Cooperation with Those Systems, 45 U. Kan. L. Rev. 9, 13 (1996) citing to Noveau Code de proc dure civile [N.C.P.C] art. 56(1), Nr. 2 (Fr.).



267 “Brief for the European Aeronautic Defense & Space Co., N.V., Alstom SA, Lagardere Group SCA, Thales SA, Technip SA and Vivendi SA,” Morrison v. National Australia Bank Limited, 2010 WL 719336 (U.S.), 28 (U.S., 2010).



Regulatory Body for SecuritiesIn France, securities regulation is governed by the Autorité des Marchés Financiers (“AMF”) (the “Financial Markets Authority”). The AMF is France’s equivalent to the US Securities and Exchange Commission. It is responsible for “safeguarding investments, ensuring that issuers disclose material information, and supervising financial markets.”268 The AMF also has created rules for securities of publicly-traded companies and reviews all disclosures by issuers of securities to verify that adequate information has been provided. The enforcement powers of the AMF include investigations of alleged securities fraud and sanctions for violations of AMF rules.269

Most recently, the French regulators have pursued investigation and enforcement charges for insider trading. The AMF brought insider-trading charges against French hedge fund, B&G, in July 2010. In February 2011, the AMF again filed insider trading charges against France’s largest publisher.270 From the perspective of many in France, regulatory bodies such as the AMF adequately regulate foreign securities on foreign exchanges and interference by the United States regulators is unnecessary.271



270 Robert F. Carangelo, Paul A. Ferrillo and Catherine Y. Nowak, Designing a New Playbook for the New Paradigm: Global Securities Litigation and Regulation, 4 (2011).

271 “Brief for the European Aeronautic Defense & Space Co., N.V., Alstom SA, Lagardere Group SCA, Thales SA, Technip SA and Vivendi SA,” Morrison v. National Australia Bank Limited, 2010 WL 719336 (U.S.), 28 (U.S.,2010).

GERMANY

OverviewGermany has a civil law system.272 There is essentially no plaintiffs’ bar in Germany due to the unavailability of class action lawsuits, stringent discovery rules, “loser pays” rule for litigation costs, and lack of punitive damages.273

Historically, class actions have not been permitted in Germany. In response to frustrations by plaintiffs and the courts over the Deutsche Telecom litigation, the German parliament adopted the Kapitalanleger-Musterverfahrengezetz (The Act on the Initiation of Model Case Proceedings in respect of investors in the Capital Markets, or more commonly, the Capital Market Investors’ Model Proceedings Act) in 2005 to allow quasi-class actions for securities fraud cases only. The law is “expressly intended as an experiment” in class action lawsuits and includes a sunset provision (it will expire in 2012 unless renewed).274 The Capital Markets Model Case Act is not a “class action” act and is limited in scope to certain claims made by investors.275

KapMuG’s term was extended for two years and it now expires on October 31, 2012. On December 30, 2011, the draft of the KapMuG was submitted to the Upper Chamber (Bundesrat) of the German Parliament.276

The revised KapMuG is largely unchanged in overall scope and approach. The only extension of scope is the inclusion of claims (tort and contract) against certain intermediaries such as brokers and investment advisers (Anlageberater und Anlagevermittler).277 Most proposed changes are technical in nature and designed to streamline the process.278 These proposals include a provision to allow plaintiffs’ attorneys extra compensation in addition to ordinary statutory

272 The German Legal Profession, Harvard Law School Program on the Legal Profession, Comparative Analyses of Legal Education, Law Firms, and Law and Legal Procedure, http://www.law.harvard.edu/programs/plp/pages/comparative_analyses.php and http://www.law.harvard.edu/programs/plp/pdf/German_legal_Profession.pdf

273 Id. at 5.274The German Legal Profession, at 5(citing Mark C. Hilgard and Jan Kraayvanger, Class Acts

and Mass Torts in Germany, IBA LITIGATION COMMITTEE NEWSLETTER (Sept. 2007), 40.)

275 Daniel Schulz & Michael B. Hixon, Germany, Chapter 14, The International Comparative Legal Guide to: Class & Group Actions 2012: A practical cross-border insight into class and group actions work, Global Legal Group, (2012).

276 Peter Bert, KapMuG: Legislative Process Started to Revise Capital Market Investors’ Model Proceeding Act, Dispute Resolution in Germany, Posted January 12, 2012, Retrieved April 14, 2012, http://www.disputeresolutiongermany.com/2011/10/kapitalanlegermusterverfahrensgesetz-looks-as-so-it%e2%80%99s-here-to-stay/

277 Schultz and Hixon, at 85.278 Peter Bert, Kapitalanlegermusterverfahrensgesetz: Looks as though it’s here to stay, Dispute

Resolution in Germany, Posted October 15, 2011. Retrieved April 14, 2012 from http://www.disputeresolutiongermany.com/2011/10/kapitalanlegermusterverfahrensgesetz-looks-as-so-it%e2%80%99s-here-to-stay/



attorneys’ fees (27000 euro), and a provision for facilitating settlements by allowing court-approved settlements to be binding on all model procedure participants unless they opt–out after notification.279 If passed, the revised law will go into effect November 1, 2012.

According to the electronic Federal Gazette, as of October 2011, there have been a total of 15 model case proceedings. Presently there have been only 4 model case decisions. The number of model case applications, however, is significantly higher.280 Unfortunately, the KapMuG does not appear to have worked very well in the Deutsch Telekom case. Reportedly the last hearing was in 2010 and the next one is scheduled for this year (2012). 281

Basics of Filing a Claim and LitigationKapMuG is designed to bundle identical or similar cases in a streamlined process. It makes sure that identical issues of law and fact are decided swiftly and coherently, but avoids the creation of a real class-action by keeping the cases brought by individual claimants separate.282

As soon as ten or more investors (within a four-month period) file claims of identical nature – against the same defendant based on the same causes of action and identical or similar facts – the individual cases are suspended. The matter is transferred to a Court of Appeal (Oberlandesgericht), which decides the identical legal or factual issues with binding effect for all pending proceedings of that “class” – class being a word not to be found in KapMuG. A type of “lead plaintiff ” argues the case at that stage on behalf of all claimants. Once the Oberlandesgericht has dealt with the issue, or, following an appeal of its decision to the Federal Supreme Court (Bundesgerichtshof), the matter is transferred back to the originating courts. It is for the originating courts to decide the individual cases in the context of the binding decisions.283

279 Axel Halfmeier, Reform of German Model Proceedings Act planned, Global Class Actions Exchange, Retrieved April 15, 2012, http://globalclassactions.stanford.edu/sites/default/files/documents/Reform%20of%20German%20Model%20Proceedings%20Act%20planned.pdf

280 Schulz and Hixon, supra at note 3. Retrieved on April 15, 2012 from http://www.iclg.co.uk/index.php?area=4&country_results=1&kh_publications_id=213&chapters_id=4826

281 Carl Karlsgodt, Notes from the 5th Annual Conference on the Globalization of Class Actions and Mass Litigation, Session 3 – Managing the Mass, ClassActionBlawg, Posted December 27, 201. Retrieved April 15, 2012 from http://classactionblawg.com/2011/12/27/notes-from-the-5th-annual-conference-on-the-globalization-of-class-actions-and-mass-litigation-session-3-managing-the-mass/

282 Peter Bert, Kapitalanlegermusterverfahrensgesetz: Looks as though it’s here to stay, Dispute Resolution in Germany. Posted October 15, 2011, Retrieved April 14, 2012 from http://www.disputeresolutiongermany.com/2011/10/kapitalanlegermusterverfahrensgesetz-looks-as-so-it%e2%80%99s-here-to-stay/

283 Id.; Louise Moher and Lynda Morgan, Germany: Multi Party Litigation In Germany: The KapMuG In Action, Class Actions, Federal Prss., Spring 2008. Posted January 10, 2012, Retrieved April 15, 2012 from http://www.mondaq.com/x/160298/Class+Actions/MultiParty+Litigation+In+Germany+The+KapMuG+In+Action

Daniel Shulz and Michael B. Hixon, in their chapter on German Group Actions in the International Comparative Legal Guide to: Class & Group Actions 2012 by the Global Legal Group, describe the process as follows:

Either the plaintiff or defendant may file for a model case proceeding in order to adjudicate certain factual or legal questions which are common to similarly filed claims. The KapMuG can be seen to operate in three distinct stages:

First, a party wishing to initiate a model case proceeding must apply to the court of first instance for the establishment of a model case. The application will include proposed model questions, and the applicant must demonstrate that said questions “may have significance for other similar cases beyond the individual dispute concerned”. (§J(2) KapMuG)

If nine applications are filed within the notice period (4 months) whose model questions refer to the same underlying circumstances, the court of first instance will order these cases to be transferred to the Higher Regional Court (OLG).

Second, the OLG will then review the transferred cases and select one case which will serve as the model case. While the model case proceeding is pending at the OLG, all proceedings at the courts of first instance, whose outcome is contingent on the ruling of the OLG, are stayed.

The model questions will be filed for the lead case and the OLG will hold a trial concerning those questions to be resolved. Once the OLG issues a decision with respect to the model case, this decision is binding on the courts of first instance.

Third, once the model case decision has been issued, the automatic stay is lifted as to the related cases and the courts of first instance will have to adjudicate each individual case separately.284

Commentators have been highly critical of the KapMuG’s procedures, which theoretically make it impossible to settle a case. Louis Moher and Lynda Morgan wrote in 2008:

At first glance, the model proceedings approach bears some resemblance to an opt-in version of the North American class action. Upon closer examination, however, several details of the KapMuG pose significant challenges to its success.

A principal challenge is the active role played by “interested parties” in the model proceedings. In order to preserve the claimant’s right to be heard, each claimant in the stayed actions is granted “interested party” status, which entitles them to produce materials and make

284 Shultz and Hixon, at 85.



submissions at the model case trial, provided their statements and actions are not contrary to those of the model claimant. (footnotes omitted)

Interested parties may also expand the subject matter of the model proceedings if the court finds that the additional issues are relevant to the model questions. This means that each and every claimant- over 17,000 in the Telekom litigation- have the right to file written materials and make submissions at each stage of the model trial. This special status has the potential to lengthen and complicate the model trial interminably.

Another significant challenge is that settlement, which is the end result of most North American class actions, is virtually impossible under the KapMuG. Subsection 14(3) of the KapMuG provides that “if all interested parties do not consent to the settlement, conclusion of model case proceedings by way of settlement shall be inadmissible. The power of the representative plaintiff to settle a class action in North America has prevented many a lengthy common issues trial and individual issues trials. The KapMuG’s requirement that all claimants must agree to a settlement renders protracted litigation inevitable.285

At the 5th Annual Conference on the Globalization of Class Actions and Mass Litigation, Sir David Steel, High Court of Justice, England & Wales (ret.) and the Honorable Ivan Verougstraete, Former President of the Belgian Court of Cassation and Visiting Professor of Law Georgetown University, squared off against each other in criticizing the German law:286

Sir David Steel did not pull any punches with his blunt criticism of the German system, commenting in summary that the “German courts need to join the modern world.” He pointed out that the prospectus fraud claims in the Telekom case are not very complicated and that it should be possible for the courts to deal with them in a much shorter period of time. He pointed to a number of simple procedural reforms that might have sped up the Telekom litigation, including reform of cumbersome clerical requirements, the imposition of a time bar for claims (he pointed out that the German proceedings had not even been commenced until 2005, roughly 5 years after the event), and rules relating to case assignments (by the time the case was ready for a ruling, the initial judge assigned to the case had reached retirement age), and discretion to impose reasonable pleading deadlines (the plaintiffs were allowed to introduce new claims as recently as 2010). He concluded by likening the Telekom case to the fictitious decades-long Jarndyce v. Jarndyce will contest in the

285 Morgan and Moher, supra.286 Karlsgodt, supra.

Dickens novel Bleak House, which had spurred judicial reforms in the UK in the Nineteenth Century….

Judge Verougstraete offered a counterpoint to Justice Steel’s criticisms by pointing out the significant cultural differences between the common law system in the UK and the civil law jurisdictions in Continental Europe. He went on to point out various constitutional, cultural, and practical barriers to significant judicial case management reforms in European civil law jurisdictions, including: 1) the individual’s right to his day in court is of paramount importance in European jurisdictions and cannot be discarded in the interest of judicial efficiency; 2) discovery reforms are not a solution in Europe because most European jurisdictions do not allow parties to engage in discovery anyway (he noted, however, that judges do have some level of control over the speed with which court-appointed experts and masters complete their investigations and findings); 3) while settlement and alternative dispute resolution procedures are theoretically possible, they haven’t worked yet in speeding the resolution of many mass actions. Judge Verougstraete also pointed to two possible alternatives to collective litigation in civil law countries: 1) use of the criminal law complaint, which places the financial cost of redress on the State but also cedes control over the litigation; and 2) bundled litigation, although even in bundled litigation, the requirement to provide individual notice to litigants often minimizes the judicial efficiencies created by joining claims together, as was seen in the Telekom matter. In closing, although he agreed with Justice Steel that civil law jurisdictions in Europe could benefit from legislative reforms streamlining judicial procedure in mass litigation, he warned that there was still the problem of legal tradition and culture, which cannot be changed overnight.

There is no system of discovery, although in some circumstances the substantive law at issue may require parties to deliver certain documents to the court or to the other party.287 The impact of the lack of discovery is mitigated by German rules on burdens of proof: “The burden will usually be shifted to the party who has access to the relevant information.”288

Punitive damages in civil cases are not permitted by law, and may be unconstitutional.289

287The German Legal Profession, at 5. (citing ABA SECTION OF ANTITRUST LAW, OBTAINING DISCOVERY ABROAD 128 (2d ed. 2005).)

288 Id., at 129.289 Volker Behr, Myth and Reality of Punitive Damages in Germany, 24 J. L. COMM. 197,

198-199 (2005).



Loser Pay ModelThe losing party must pay all litigation costs, including court costs and the losing party’s attorney fees.290 The Rechtsanwaltsvergütungsgesetz (Law on the Regulation of Attorneys’ Fees) contains a series of schedules that establish flat fees for attorney services (statutory fees). Clients and attorneys may agree to a negotiated hourly rate in lieu of the statutory fee. However, the losing party is only liable for an amount equal to the statutory fee. Costs are distributed proportionally if a party partially wins.291

Opt-in vs. Opt-outThe KapMuG is arguably neither “opt-in” nor “opt-out” in the strict sense of the term. Once an individual plaintiff has filed a lawsuit to which the model case proceeding is relevant, they are included as an “interested party” to the model case. These interested parties may participate in the model proceeding as third party petitioners (as long as their submissions do not conflict with that of the model case petitioner). However, the fact remains that regardless of whether the interested parties decide to participate in the model case or not, they technically have no choice to “opt-in” or “opt-out” but are automatically bound by the model case decision.292

Extraterritorial JurisdictionThe extraterritorial jurisdiction for claims of compensation appears to be limited.

The various statutes under which a claim may be made under the KapMuG usually refer to securities traded on a German stock exchange, traded on the free market, or admitted to trading on an organized market in another Member State of the European Union or in another of the Contracting States to the Agreement on the European Economic Area.293

Funding the litigation- contingent fee arrangementsContingent fees traditionally were not permitted. However, a 2006 decision of the German Constitutional Court held that a blanket ban on contingent fees was unconstitutional.294 The German parliament subsequently passed a law allowing contingent fees if the client otherwise would not be able to enforce or defend his or her legal rights.295

290 The German Legal Profession at 4, citing Zivilprozeßordnung [ZPO] (Civil Procedure Code), § 91.

291 Id., § 92.292 Schulz and Hixon, supra. at note 3.Retieved on April 15, 2012 from http://www.iclg.

co.uk/index.php?area=4&country_results=1&kh_publications_id=213&chapters_id=4826

293 Securities Trading Act (Gesetzüber den Wertpapierhandel/ Wertpapierhandelsgesetz - WpHG), Retrieved April 15, 2012, from http://www.iuscomp.org/gla/statutes/WpHG.htm#142.

294The German Legal Profession (citing Bundesverfassungsgericht [BVerfGE] [Federal Constitutional Court] Dec. 12, 2006, 1 BVR 2576/04 (F.R.G.)).

295 Id., citing Rechtsanwaltsvergütungsgesetz [RVG] (Law on the Regulation of Attorney’s Fees), § 4a.

Litigation funding is allowed in Germany, and without regulation. As recently reported by Peter Bert:

Third-party litigation funding may be, for once, a legal service where Germany has had a head start over the UK. German law was not burdened by the equivalent of the common law doctrines of champerty and maintenance …, and no contractual obstacles had to be overcome to offer litigation funding. In addition, no regulatory hurdles exist: Litigation funding does not qualify as insurance or financial service, nor does it fall within the scope of legal services, and hence, is entirely unregulated. The prevailing doctrine views the litigation funding agreement as a kind of partnership (Gesellschaft) between claimant and funder. German litigation funders usually cover the liability for adverse costs, since, under the German statutory fee schedules, these can be predicted with great accuracy in most cases. As a consequence, ATE (after the event) insurance is of little or no relevance in the domestic market. In international disputes or in arbitration however, where the German costs regime does not apply, the need for ATE insurance may arise.

In Germany, since the late 1990s, about ten providers established themselves in the market; the German Bar Association (Deutscher Anwaltverein) provides an overview on their website. The pioneers were FORIS, who are a listed stand-alone entity. Following in their footsteps were some of the major insurance companies. Allianz, DAS and Roland all set up litigation funding subsidiaries.296

Further research may reveal that litigation costs are more regulated and predictable in Germany such that litigation funding is considered profitable. In a note from the International Conference of litigation funding, Oxford University, May 19, 2010, Dr. Arndt Everber, AllianzProcessFinanz reported:

The architecture of the civil justice system in Germany, with tariffs for lawyers’ costs and shiftable lawyers’ costs, encourages before-the-event (BTE) legal expenses insurance (LEI), which has long been held by many individuals. Litigation funding (LF, an after-the-event, ATE) bespoke product for consumers and SME companies, spread from around 2000, when major insurers entered the market. There are currently around 12 companies, with a ‘big 4’. Allianz is one of these, and assessed 5,000 claims worth around €500 million. Historically, contingencies fees were not allowed in Germany (there has been a recent but very limited permission for contingency fees) and banks were not providing funding for cases without securities. Now, around 50% of clients are consumers and 50% are companies (mainly SMEs). Cases

296 Peter Bert, Third-Party Litigation Funding: Movements in the German Marketplace, Dispute Resolution in Germany. Posted December 12, 2011. Retrieved April 15, 2012, from http://www.disputeresolutiongermany.com/2011/12/third-party-litigation-funding-movements-in-the-german-marketplace/



funded are mostly individual cases, but there are some class actions. Every case is assessed by a risk assessment committee. The tariff system for lawyers’ fee in Germany means that it is simple to assess costs. In the UK, in contrast, litigation costs are much harder to asses, and much higher than in Germany, which increases funding costs. The loss rate is roughly 1 in 10. 90% of cases are settled before judgment. Profit is usually around 30%.

Litigation funding is widely known by lawyers but seldom used by them in practice (only 5% of Allianz’s cases come from lawyers). The general public, however, does not know about funding due to a lack of publicity.297

Fraud on the Market TheoryReliance is not an element of a cause of action under the Securities Trading Act, (Wertpapierhandelsgesetz or WpHG). It is a defense:

Part 7 Liability for Incorrect or Omitted Capital Market Information Section 37b Liability for Damages Due to Failure to Publish Inside Information without Undue Delay

(1) If an issuer of financial instruments that are admitted to trading on a German stock exchange fails to publish, without undue delay, inside information that directly affects that issuer, he shall be liable to compensate a third party for the damage resulting from the omission if the third party

1. has bought the financial instruments after the omission and still owns the financial instruments upon disclosure of the information or

2. has bought the financial instruments before the existence of the relevant insider fact and sells them after the omission

(2) Those issuers who can prove that the omission was made neither deliberately nor in an act of gross negligence shall not be liable for damages pursuant to subsection (1).

(3) Claims for damages pursuant to subsection (1) shall not exist if, in the case of subsection (1) no. 1, the third party knew about the undisclosed fact at the time of purchase and, in the case of subsection (1) no. 2, the third party knew about the undisclosed fact at the time of sale.

(4) Claims for damages pursuant to subsection (1) are subject to a limitation period of one year from the date

297 Notes, International Conference on Litigation Funding Oxford University, 19 May 2010. Retrieved April 15, 2012 from www.csls.ox.ac.uk/documents/1005ConferenceReport.doc

on which the third party learned of the omission, but not more than three years after the omission.

(5) This is without prejudice to further contractual claims or claims in intentional tort which may be raised under the provisions of civil law.

(6) Any agreement which reduces the claims to be brought by an issuer against the members of the board of management based on claims for damages against the issuer pursuant to subsection (1) or which relieves the members of the board of management of such claims shall be deemed invalid.

Section 37c Liability for Damages Based on the Publication of False Inside Information

(1) If an issuer of financial instruments that are admitted to trading on a domestic stock exchange publishes false inside information that directly affects that issuer in a notification pursuant to section 15, he shall be liable to compensate a third party for the damage resulting from the fact that the third party relied on the accuracy of the inside information, if the third party

3. has bought the financial instruments after publication and still owns the financial instruments at the point in time at which it becomes publicly known that the information was inaccurate or

4. has bought the financial instruments before publication and sells them before it becomes clear that the information was inaccurate.

(2) Those issuers who can prove that they were not aware of the inaccuracy of the inside information and that such lack of awareness does not constitute an act of gross negligence shall not be liable for damages pursuant to subsection (1).

(3) Claims for damages pursuant to subsection (1) shall not exist if, in the case of subsection (1) no. 1, the third party knew that the inside information was inaccurate at the time of purchase and, in the case of subsection (1) no. 2, the third party knew that the information was incorrect at the time of sale.

(4) Claims for damages pursuant to subsection (1) are subject to a limitation period of one year from the date



on which the third party learns of the inaccuracy, but no more than three years after publication.

(5) This is without prejudice to further contractual claims or claims in intentional tort which may be raised under the provisions of civil law.

(6) Any agreement which reduces the claims to be brought by an issuer against the members of the board of management on grounds of claims for damages pursuant to subsection (1) or which relieves the members of the board of management of such claims shall be deemed invalid.298

Pleading StandardsGerman pleading standards are strict and require much more detail than those in the United States:

This American federal pleading standard is quite exceptionalist; no other country’s pleading requirements are so relaxed. Civil law countries, as typified by Germany and France, require substantially more than the American system’s focus on notice pleading. In Germany, the initial complaint occupies a place of central importance. (Internal citations omitted) Consequently, the German system requires “specific fact pleading and does not permit mere notice pleading.” German procedure also requires a party to designate the means of proof (for example, by identifying documents and witnesses) for each factual assertion in the pleadings.299

German law professor Peter Schlosser has described the factual requirements of the complaint:

In Germany, litigation starts with the submission of a written statement to the court . . . [that] is a very extensive, detailed and, if it comes from a qualified attorney, very carefully drafted paper. . . . If documentary evidence is available, it will usually be enclosed. Should circumstantial evidence exist, it is also explained to the judge in the statement of claim and may be emphasized by copies of relevant documents and other materials.

Peter F. Schlosser, Lectures on Civil-Law Litigation Systems and American Cooperation with Those Systems, 45 U. KAN. L. REV. 9, 12 (1996) (footnote omitted).300

298 English Translation of German Securities Trading Act, BaFin - Securities Trading Act. Retrieved April 15, 2012 from http://www.bafin.de/cln_235/nn_720786/SharedDocs/Aufsichtsrecht/EN/Gesetze/wphg__101119__en.html#doc1958240bodyText92

299 Scott Dodson, Comparative Convergences in Pleading Standards, University of Pennsylvania Law Review, Vol. 158: 452-53 (2010). Retrieved April 15, 2012 from http://www.law.upenn.edu/journals/lawreview/articles/volume158/issue2/Dodson158U.Pa.L.Rev.441(2010).pdf

300 Dodson at 452-3, footnote 71.

Causes of Action in Securities LitigationThe scope of the KapMuG encompasses: (1) claims for damages on account of false, misleading or omitted public capital markets information, and (2 ) claims which are based on an offer under the Securities Acquisition and Takeover Act (Wertpapiererwerbs- undUbernahmegesetz or “WpUG”).301 The claims shall relate to information contained in:

1. Prospectuses under the Securities Prospectus Act,

2. Sales prospectuses under the Sales Prospectus Act and the Investment Act,

3. Communications of insider information within the meaning of section 15 of the Securities Trading Act,

4. Presentations, overviews, lectures and information in the main collection on the state of the company, including its relationships with associated enterprises within the meaning of section 400 (1) no. 1 of the Stock Corporation Act,

5. Annual financial statements, annual reports, group financial statements, group annual reports and interim reports of the issuer, and in

6. Offering documents within the meaning of section 11 (1), first sentence, of the Securities Acquisition and Takeover Act.302

Regulatory Environment for Securities LitigationIn recent years, Germany has implemented a series of laws to improve its securities trading system, including laws against insider trading and the Fourth Financial Market Promotion Law in 2003. In 2002, a corporate governance code was adopted, which, while voluntary, requires listed companies to “comply or explain” why the code or parts thereof have not been followed. The code is intended to increase transparency and improve management response to shareholder concerns. The Finance and Justice Ministries drew up a ten-point plan in 2003 to improve investor protection. As a part of that plan, the government tabled a bill in November 2004 that would (a) increase the liability of boards of directors for false or misleading statements; and (b) improve oversight of auditing operations. The EU’s Financial Services Action Plan – an effort intended to create a more integrated European financial market by 2005 – has helped stimulate changes in the German regulatory framework, including adoption of International Accounting Standards for listed firms and use

301 Shultz and Hixon, at 8.302 Act on the Initiation for Model Case Proceedings in respect of Investors is the Capital

Markets, Global Class Actions Exchange. Retrieved April 15, 2012 from http://globalclassactions.stanford.edu/sites/default/files/documents/Germany_Legislation_1.pdf



of company investment prospects on an EU-wide basis. In 2008, Germany passed legislation that makes private equity firms subject to greater transparency rules, including the publication of a business plan for the acquired company.303

On May 1, 2002, the Federal Banking Supervisory Office (Bundesaufsichtsamtfür das Kreditwesen – BAKred) was merged with the then Federal Securities Supervisory Office (Bundesaufsichtsamtfür den Wertpapierhandel – BAWe) and Federal Insurance Supervisory Office (Bundesaufsichtsamtfür das Versicherungswesen – BAV) to become the Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). BaFin is responsible for the supervision of Banking, Insurance and Securities. According to BaFin’s website:304

Securities supervision is the most recent discipline in German financial supervision. Its origins date back to the Second Financial Market Promotion Act, which was passed on 26 July 1994. This Act introduced a radical reform of the German regulatory system for securities markets. Its principal objective was to ensure the efficiency – and thus the international competitiveness – of Germany as a financial market. One of the key elements of the reform was the establishment of the Federal Securities Supervisory Office (Bundesaufsichtsamt für den Wertpapierhandel – BAWe) in Frankfurt am Main, which commenced work on 1 January 1995. This was the first time that a Federal authority had been assigned responsibilities for the supervision of Germany’s securities markets.

The basis for the fledgling Securities Supervisory Office’s duties was the Securities Trading Act (Wertpapierhandelsgesetz – WpHG) – an important element of the Second Financial Market Promotion Act – most of which came into force on 1 January 1995. Under this Act the Supervisory Office was charged with ensuring the integrity and transparency of the German capital market – by combating and preventing insider trading, by monitoring ad hoc disclosure by listed companies and the disclosure requirements applying to changes in voting rights in listed companies and by monitoring compliance with the codes of conduct applying to investment services firms – all in the name of improved investor protection.

303 U.S. Department of State, Bureau of Economic, Energy and Business Affairs, 2011 Investment Climate Statement—Germany (March 2011). Retrieved April 11, 2012 from http://www.state.gov/e/eb/rls/othr/ics/2011/157282.htm

304 History of BaFin. Retrieved April 15, 2012, from http://www.bafin.de/cln_235/nn_721608/EN/BaFin/Legalbasis/History/history__node.html?__nnn=true#doc721614bodyText3.

Almost all of the provisions of the Securities Trading Act are based on European Directives. The Act has therefore been amended and adapted to take into account developments in the securities markets on a number of occasions by now. For instance, … The Third Financial Market Promotion Act, which came into force in 1998, increased BAWe’s existing rights to obtain information in connection with investigations into insider trading and extended the notification requirements applying to holders of voting rights in listed companies. In January 2002 the Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz – WpÜG) gave the Supervisory Office the job of monitoring company takeovers for the first time ever. The most recent change was brought in by the Fourth Financial Market Promotion Act of 2002. For instance, since then the securities regulator has also been responsible for monitoring the prohibition on price and market manipulation and oversees the notification and disclosure of directors’ dealings. In addition, the provisions relating to the misuse of ad hoc announcements for advertising purposes and the publication of false information have been strengthened.



JAPAN

Trends in Securities LitigationIn Japan, it is no longer rare for a large number of investors to file a lawsuit against a corporation that made false and misleading statements in its disclosure documents. Even without a class action system, some attorneys have become skilled at organizing enormous numbers of potential plaintiffs and filing consolidated lawsuits, once corrective disclosures reveal the false and misleading representations. Notably, in 2004, the Securities and Exchange Law (the SEL) was revised, introducing a provision for estimating damages related to periodic disclosure, which lessens the plaintiff ’s burden of proving damages. This change contributed to the recent increase in securities litigation.

Currently in Japan, following the resolution of a few large cases including Livedoor and Seibu Railway, the number of judgments in misstatement cases has decreased substantially to seven in 2010 from 14 in 2009. On the other hand, the number of litigations between financial institutions, including securities companies, and their customer investors reached a record high of 44 in 2010.

The notable cases filed in 2010 include a lawsuit in which shareholders claimed damages over false and misleading statements against FOI Corporation, a manufacturer of production equipment of semiconductors listed on the Tokyo Stock Exchange’s (TSE) junior market Mothers Board (“Mothers”), and Futaba Industrial Co., Ltd., an automotive parts manufacturer listed on the First Section of the TSE. In the FOI case, the shareholders allege that the company misstated its sales since its listing on Mothers, and have filed complaints against the management, accountants, underwriters, and the TSE. This is the first case in which the stock exchange has been questioned for its responsibility in listing examination.

Another recent notable filing is a cross-border case in which Toyota Motor’s (Toyota) shareholders in the United States have filed a suit against Toyota alleging that insufficient disclosure of its recall risk was false and misleading under Japan’s Financial Instruments and Exchange Act, formerly known as the SEL (FIEA).

Two Forms of Group ProceedingsIn Japan, court decisions, in principle, are not binding on third parties, and there is no class action system that allows a group to claim damages.305 As a result, group proceedings need to be maintained as (1) joint proceedings or (2) appointed party proceedings.

Joint ProceedingsPursuant to Article 38 of the Code of Civil Procedure (C.C.P.), when (i) the rights and obligations which the claimants seek to enforce are common; (ii) the claims are based on the same factual or legal cause; or (iii) the rights and obligations which the claimants seek to enforce are of the same kind and are based on the same kind of factual or legal cause, the persons may sue or be sued as co-litigants. While they do not represent one another, co-litigants appoint the same attorneys and jointly litigate as a group. Because it requires proactive participation by the plaintiffs to get involved, a joint proceeding is akin to the “opt-in” procedure. In such a joint proceeding, litigants can seek any remedy under the C.C.P., including monetary damages, injunctive relief, and declaratory relief.

Typically a joint proceeding does not involve a large number of litigants. Instead, it usually combines a relatively small number of local litigants, even when country-wide damages are at issue. Occasionally, however, joint proceedings can involve as many as several hundred co-litigants.

In addition to making discovery more economical by having litigants share the burden of the cost, joint proceedings can make the processing fee relatively more affordable for each individual. For example, suppose the processing fee for an action involving ¥1 million for a single individual is ¥8,600. If 100 people initiate actions asking for the same amount in damages, the combined amount in dispute would be ¥100 million and the processing fee would be ¥410,760. Therefore, use of joint proceedings can cause a reduction of the fees by more than 50 percent.

Also, similarly situated individuals can benefit from having one uniform judgment. But, the court has discretion to decide whether a joint proceeding should be maintained, and the court can choose to resolve a dispute in separate proceedings or issue different judgments. Also, if a joint proceeding is filed by plaintiffs who do not satisfy the requirements under Article 38 of the C.C.P. and the

305 A relatively new system for consumer group action is available pursuant to the June 2007 amendment to the Consumer Contract Act. This system gives standing to consumer groups to sue on behalf of consumers and seek injunctive relief. These groups must be certified by the Prime Minister in advance, and they may not claim damages.



defendant makes an objection without delay, the court will separate the proceeding.

Appointed Party Proceedings306

Pursuant to Article 30 of the C.C.P., a number of persons who share a common interest may appoint a party to file a lawsuit on their behalf. All remedies under the C.C.P. are available in appointed party proceedings, including monetary damages, injunctive relief, and declaratory relief. A decision of the court, in principle, is only binding on the appointed party, the defendants, and the appointers. A decision does not bind persons who share a common interest but did not authorize the appointed party to act on their behalf. This procedure, again, resembles the “opt-in” process.

To file an appointed party proceeding, the following requirements must be met: (i) the group of persons who share the same interest must exist;307 (ii) the appointed party must be selected from the group; and (iii) if the group is qualified to file a lawsuit under the name of the group itself (C.C.P., Article 29), the litigation cannot be conducted by the appointed party (C.C.P., Article 30). An appointed party proceeding will be dismissed for procedural reasons if the requirements under Article 30 of the C.C.P. are not met.

Unlike the United States’ class actions in which the class representatives are automatically deemed authorized to represent the class, the appointed party in the Japanese proceedings must be appointed expressly by each individual member of the group. Consequently, the scale of these appointed party proceedings is limited by the ability to identify group members and obtain their consent.

Traditionally, individual members withdraw from the litigation after appointing their representatives, and the action proceeds with only a few appointed parties. Subsequent to the 1996 reform, a person can appoint a representative without having to file his or her own complaint first.

Attorneys’ FeesFor civil litigation in Japan, parties may decide whether or not to hire attorneys because there is no requirement for representation by attorneys. Consequently, no attorneys’ fees are awarded even if one party wins, and both parties must bear the fees. But, there is one exception: in connection with tort-related litigation, some courts have approved the winning party’s inclusion of attorneys’ fees in the calculation of damages.

306 Until 2007, this system had never been utilized since the reform of the C.C.P. in 1998.307 Specifically, those persons must satisfy the requirements for a joint proceeding and their

main allegations must have commonality.

The remuneration for attorneys in Japan is not as substantial as it would be in the United States. Even if a lawyer organizes a group proceeding, individual authorization is required, limiting both the total number of parties and the total amount in dispute. Even if the attorney wins a case, the attorney can only receive remuneration from part of the recovery. As a result, attorneys rarely take the initiative to organize a group of plaintiffs. In practice, typically a retainer is approximately five to ten percent of the amount in dispute. Additionally, when a party receives a certain sum of money as a result of the court’s decision or settlement, another five to ten percent of the amount typically goes to the attorneys.

CostsIn Japan, litigation costs are borne by the losing party unless otherwise allocated by the court (C.C.P., Article 61). Litigation costs under the C.C.P. do not include attorneys’ fees, and are limited to matters such as payments to witnesses, fees arising from service of court documents, and fees for filing a lawsuit. If a party withdraws a lawsuit or abandons its claim, that party needs to pay the litigation costs relating to its own claim.

Funding for the LitigationThe Japan Federation of Bar Associations mandates that attorneys’ fees always be appropriate. Conditional or contingency fees might become inappropriate if the attorneys’ fees become too high. Also, while funding by a third party is generally not prohibited, attorneys are not allowed to lend money to their clients unless there are special circumstances, such as an emergency that requires the advance payment of litigation costs.

Pleading StandardsA complaint must contain the following: (1) names and addresses of parties; (2) relief sought, including the amount to be paid by the defendant; (3) claims for relief with supporting facts; and (4) legal grounds to establish the claim.

The plaintiff must set forth the relevant facts and the evidence that are material to prove the complaint so that the court may understand the nature of the dispute and claims at an early stage.

The plaintiff may change and/or add a claim if the following conditions are satisfied: (1) the change and/or addition of a claim will not result in excessive delay of court proceedings; (2) the common nucleus of operative facts is the same; (3) the change and/or addition of the claim occurs before the conclusion of a series of court hearings; and (4) the claim sought to be added does not fall within the exclusive jurisdiction of another court.



However, the court has discretion not to allow changes or additions if it concludes they are inappropriate.

Liabilities for False and Misleading StatementsThe FIEA sets out severe liabilities for false and misleading statements, including civil liabilities and administrative penalties for the corporation, directors, auditors, certified public accountants, and auditing firms. In addition, the corporation and the person who filed the documents could be liable for criminal penalties.

First, if the offering documents contain false and misleading statements on material matters, the corporation is strictly liable to third parties who acquired securities through either a public offering or secondary distribution. The amount of damages is calculated by deducting the following items from the amount paid by the plaintiff to acquire the securities: (a) the market value of the securities at the time of the claim for damages; or (b) the disposal value of the securities, if the securities were disposed of before the time referred to in item (a). If the defendant proves that all or part of the plaintiff ’s damages were caused by any reason other than the decline in the value of the securities arising from the false and misleading statements in the offering documents, the defendant is not liable for that part of the damages. Thus, the burden of disproving causation and the amount of damages rests on the defendant.

Second, if periodic disclosure documents contain false and misleading statements on material matters, the corporation is strictly liable to third parties who acquired securities, during the period when the disclosure documents were made publicly available, not through public offering or secondary distribution, up to the amount calculated according to the same formula as applied in the case of false and misleading statements in the offering disclosure documents.

The provisions regarding civil liability for periodic disclosure documents were introduced in 2004. As explained above, issuers of securities may be liable for damages even if there is no fault on their part. The issuer’s liability in this context is more severe in Japan than in the United States, because the SEC Rule 10(b)-5 restricts the issuer’s liability to cases where the defendants had scienter.

The Fraud-On-The-Market TheoryUnder the FIEA, the damages caused by the false and misleading statements in the periodic disclosure documents are presumed to be those calculated by deducting the average market value for one month after the day on which the existence of false and misleading statements was announced (Disclosure Date) from the average market value for one month prior to the Disclosure

Date, for plaintiffs who acquired securities within one year prior to the Disclosure Date and continuously possessed them up to the Disclosure Date. As discussed above, the burden of disproving causation and the amount of damages rests on the defendant.

Finally, the drafters of the FIEA considered the difficulties for the courts to determine the amount of damages in cases where all or part of the plaintiffs’ damages were caused by reasons other than the decline in the value of the securities arising from false and misleading statements in the periodic disclosure documents. The FIEA therefore provides that the court may exercise discretion to determine a “reasonable” amount where damages are difficult to assess.

Application: The Livedoor Case StudyThe impact of the introduction of new provisions regarding the civil liability for false and misleading statements in the periodic disclosure documents was demonstrated in the large scale lawsuits against Livedoor, an operator of Japanese web portals. In one consolidated lawsuit, 3,320 individual investors and 25 corporations became plaintiffs, claiming approximately ¥19.3 billion ($206 million) in damages. On May 21 2009, the Tokyo District Court ordered Livedoor and other defendants to pay approximately ¥7.7 billion ($82.2 million).

The defendants in the case were Livedoor and its affiliate corporations, as well as the founder and then representative Takafumi Horie (Horie), and other executives. These defendants were allegedly involved in using illegal means, such as spreading rumors, to cause price fluctuations in the corporation’s stock price, and for submitting an annual securities report containing false and misleading statements on material matters. Prior to the filing of the civil litigation, Horie and other executives were arrested in January 2006 on criminal charges, and the arrest of Horie led to a sharp decline in the share price of Livedoor. In the civil action, plaintiffs argued that the defendants’ liabilities were clear because Livedoor’s periodic disclosure documents contained false statements, and the plaintiffs had to purchase Livedoor’s shares at artificially inflated prices.

As explained above, the amount of damages arising from false and misleading statements is calculated based on the average market value before and after the Disclosure Date. Livedoor did not voluntarily announce that its periodic disclosure documents had contained false and misleading statements before the arrest of Horie. Rather, media coverage over the criminal investigation of Livedoor triggered the substantial drop in the stock price. If the Disclosure Date had been interpreted to mean the day after such media coverage, the damages calculated would be



significantly lower, because Livedoor’s market share price had already dropped. The Tokyo District Court, clearly siding with the plaintiffs, found the Disclosure Date to mean the day on which the prosecutor in charge of the investigation made the announcement, and awarded a substantial amount of damages to the plaintiffs.

The Tokyo District Court found that the damage plaintiffs suffered was ¥585 ($6.2) per share. However, the court determined, in its discretion, that only 34.2 percent of such damages, or ¥200 ($2.1) per share, should be awarded to the plaintiffs because the remainder of the damages were caused by reasons other than the false and misleading statements, such as the commencement of the criminal investigation against Livedoor, the arrest of Horie, and the increased possibilities of delisting from the TSE. Because the FIEA provides the courts with broad discretion on determination of damages, different judges may reduce the damages inconsistently. In another lawsuit against Livedoor filed by Nippon Life Insurance, for example, the Tokyo District Court found that the plaintiffs’ damages arising from the misdeeds of Horie and others was ¥585 ($6.2) per share, but that 70 percent of such damages should be awarded to the plaintiffs.

There are different views with regard to the interpretation of “damages arising from the false and misleading statements.” One view is that the amount of damages is the difference between the actual purchase price paid by the investor and the hypothetical stock price assuming that no false statements were in the disclosure documents. Another view is that damages should be the amount of the drop in the stock price triggered by the corrective disclosure. There is yet another view that the actual purchase price paid by the investor is the amount of the said damages, because the investor would not have bought the stock had such false and misleading statements not existed.

The Tokyo District Court judgment explained above, which awarded only ¥200 ($2.1) per share to the plaintiffs, appears to have taken the first view, and decided that the amount of the drop in the stock price caused by events such as commencement of the criminal investigation against Livedoor, the arrest of Horie, and the increased possibilities of delisting from the TSE, should not be included in the damages. However, other judges may reach substantially different conclusions.

THE NETHERLANDS

Trends in Securities Litigation The Netherlands may soon become the most popular forum for plaintiffs seeking monetary relief on behalf of investors in multiple jurisdictions as well as defendants seeking a binding opt-out settlement on securities claims against them. On January 17, 2012, the Amsterdam Court of Appeal declared an international collective settlement involving Converium Holding AG (Converium) to be binding on members of the class who did not opt out even though the defendants and most of the plaintiffs were not located in the Netherlands. The court reached this decision under the Dutch Act on the Collective Settlement of Mass Claims (Wet collectieve afwikkeling massaschade, commonly known as WCAM).308 In principle, the holding should be recognized in all European Members States as well as Switzerland, Iceland and Norway.

Collective Actions and the Dutch Act on the Collective Settlement of Mass ClaimsCollective actions in the Netherlands are governed by Article 3:305a BW (Burgerlijk Wetboek) of the Dutch Civil Code. This law allows collective actions to be filed by a representative organization or foundation with legal authority to sue on behalf of a group of injured individuals or entities that have opted-in to the foundation. The court must approve the foundation’s lawsuit and find that the interests of the individuals in the foundation are sufficiently similar so that they can be dealt with in a single declaratory action. Judgments entered under this provision are only binding on members of the foundation – i.e., it is an opt-in class.

More significant is that WCAM allows the representative party to reach an opt-out settlement with defendants onbehalf of class members outside of the foundation. The primary features of WCAM’s settlement provision include:

• Parties negotiate an out-of-court settlement of mass claims;

• Claimants are represented by one or more foundations and associations;

308 The WCAM is set forth in Articles 907-910 of Book 7 of the Dutch Civil Code (“DCC”) and Article 1013 of the Dutch Code of Civil Procedure or Wetboek van Burgerlijke Rechtsvordering (“DCCP”).



• Representative organizations may be preexisting or established for the purpose of negotiating a settlement;

• Settling parties jointly petition court for settlement approval;

• Court-approved notice;

• Opportunity for objectors to come forward and be heard;

• Court reviews and approves settlement;

• Notice of settlements and opt-out period; and

• Settlement administration by private foundation.

Once the Amsterdam Court of Appeal holds that the settlement agreement is binding, the settlement binds all persons covered by the class unless a person decides to opt out within a certain time period. There is no right of appeal for class members after the court approves the settlement. Settlements are administered by private foundations established specifically for this purpose.

The Amsterdam Court of Appeal has issued six decisions involving settlements under WCAM. These settlements include

• DES (2006) (Product Liability): 34,000+ members, 38 million Euros

• Dexia (2007) (Financial services): 300,000 members, 1 billion Euros

• Vie d’Or (2009) (Insurance): 11,000 members, 45 million Euros or $5.7 million dollars (U.S.)

• Shell (2009) (Securities): 500,000 members, 352.6 million dollars (U.S.)

• Vedior (2009) (Securities): 2,000 members, 4.25 million Euros

• Converium (Securities): 12,000 members, 58.4 million dollars (U.S.)

While the first three settlements followed a decision in a Dutch collective action proceeding, the latter three settlements have not. The most significant aspect of the settlements in the latter three – Shell, Vedior, and Converium – is that all involved securities claims and were cross-jurisdictional in scope.

Securities Settlements Under WCAMThe Amsterdam Court of Appeal has issued three decisions involving international securities settlements. First, in May 2009, the Amsterdam Court of Appeal declared an international settlement to be binding on an international class in the “Shell Reserves” case under WCAM. In

that case, shareholders were allegedly harmed by false statements about Shell’s oil and gas reserves that were made by the company and various officers beginning in 1999. In January of 2004, the stock price dropped after Royal Dutch/Shell announced a re-categorization and reduction in its oil reserves and the resignation of three Shell executives. One of the Shell entities was in the Netherlands, while the other was in the United Kingdom. Most shareholders lived outside of the Netherlands.

Investors brought securities class actions in the United States. However, before the U.S. court issued a final ruling, Shell reached a collective settlement with non-US investors and applied to the Dutch court to have it declared binding on all non-US investors. In particular, Shell agreed to pay a total of $381 million to non-U.S. investors.

Shell has also agreed to request that the United States Securities and Exchange Commission (the S.E.C.) distribute to shareholders the US$120 million paid by Shell in 2004 under a consent agreement resolving the S.E.C.’s investigation into Shell. Finally, the law firms representing the foundation and two Dutch pension funds reportedly negotiated a fee of $47 million for their role in negotiating the settlement

The parties jointly filed a petition under WCAM seeking approval of the international settlement. On November 20, 2008, the petition was heard by Amsterdam Court of Appeals. On May 29, 2009, the court held that it had jurisdiction to hear the case and to issue a decision that bound non-U.S. claimants, even those not residing in the Netherlands, in order to prevent contradictory rulings. The Shell settlement resolved the claims of all investors in 100 jurisdictions worldwide, excepting only those investors residing in the United States who purchased their shares on U.S. stock exchanges.

A few months later, in July 2009, the Amsterdam Court of Appeal approved and declared binding a settlement worth approximately $5.7 million for losses allegedly suffered by investors who sold their Vedior stock prior to a suspension in trading at a time when allegations were spreading that Vedior was about to be acquired. The foundation representing the class alleged that Vedior violated Dutch securities laws that required it to release certain information earlier. The settlement is significant because it was the first settlement under WCAM to include North American investors.



Third, and finally, on January 17, 2012, the Amsterdam Court of Appeal held that an international settlement was binding in a case where none of the defendants and only a limited number of the investors resided in the Netherlands. The case involved Converium Holding AG, a Swiss reinsurance company (now known as SCOR Holding AG). Converium was a wholly owned subsidiary of Zürich Financial Services Ltd. (ZFS).

In 2001, ZFS sold all its Converium shares in an IPO and Converium shares were listed on the SWX Swiss Exchange. Converium American Depositary Shares were listed on the New York Stock Exchange. The price of Converium stock declined after the company announced increases in its loss reserves in the period from 2002 through 2004.

Investors brought a class action in the United States District Court for the Southern District of New York, and the court certified a class consisting of all U.S. persons who had purchased Converium securities on any exchange, as well as all persons— regardless of their residence—who had purchased Converium securities on a U.S. exchange. The U.S. court excluded from the class all non-U.S. persons who had purchased Converium securities on any non-U.S. exchange. The U.S. action then settled with the court’s approval.

The Court of Appeal’s reasoning in Converium largely followed the same line of reasoning as a previous decision in Royal Dutch/Shell (Shell). However, the Converium settlement had fewer connections with the Netherlands than the Shell settlement as none of the interested persons were domiciled in the Netherlands. The Court emphasized the significance of a Dutch foundation representing the interested persons and having to distribute the settlement relief under the settlement agreement. Thus, it appears that without any interested persons domiciled in the Netherlands, the Court could have jurisdiction to declare the settlement binding so long as the foundation was located in the Netherlands.

All Member States of the European Union, Switzerland, Iceland and Norway will, in principle, have to recognize the Converium decision. However, no case law on this issue exists yet and whether other countries will also recognize it depends on local law. Nonetheless, after Converium, the Netherlands is Europe’s most popular forum for facilitating international settlements in securities actions.

Requirements for Showing Liability for False and Misleading Statements Under Dutch law, investors do not have to show scienter to recover damages as Dutch law presumes, if the misrepresentations were made in the company’s public filings and the directors, that executive management, and the supervisory board members were responsible for them (likewise, Dutch tort rules do not pose a scienter requirement). The burden shifts to the director or supervisory board member to prove that the statement is not attributable to him or her.

Proving causation under Dutch law is similar to proving causation under U.S. law. A theory similar to U.S. fraud-on-the-market doctrine applies when showing reliance on the public misstatement. Plaintiffs must also must show loss causation--that the damage was related to the event giving rise to the liability.

Damages under Dutch law are determined by the amount of artificial inflation in the stock price caused by the misrepresentations. However, recovering damages may be more favorable in the Netherlands because the Dutch court has the authority to assess damages in the manner it considers most appropriate. Thus, investors may raise any plausible damage theory that can be supported and the Dutch court has the freedom to estimate the damage if it cannot be determined precisely.

Attorneys’ Fees and CostsIn the Netherlands, Dutch attorneys are barred by the rules of ethics from taking cases on a contingency fee basis.309 The losing party is potentially liable for a portion of the prevailing party’s legal fees and costs as well as court costs. However, the winning party does not recover the actual costs of the litigation because costs are based on certain standard amounts for certain standard activities and the amount of the claim and that costs for legal representation are awarded on the basis of fixed amounts which usually do not cover the real costs.310

309 For a report (in Dutch, but with an English summary) on European practices regarding attorneys’ fees, see Michael G. Faure, Ton Hartlief, NielsPhilipsen, Resultaatgerelateerdebeloningssystemenvooradvocaten: Eenvergelijkendebeschrijving van beloningssystemenvooradvocaten in eenaantallanden van de EuropeseUnie en Hong Kong [Result-Related Remuneration Systems for Lawyers: A Comparative Law Description of Remuneration Systems for Lawyers in a Number of E.U. Member States and in Hong Kong] (2006), available at http://www.wodc.nl/onderzoeksdatabase/internationale-vergelijking-beloningssystemen-advocatuur.aspx.

310 See Access to Civil Procedure Abroad § 8.9.3 (Henk J. Snijders ed., 1996).



SOUTH KOREA

OverviewKorea enacted new legislation providing for class actions against relatively large companies commencing on January 1, 2005 (and other companies from January 1, 2007).311

The new Securities Related Class Action Act (SRCAA) was enacted to improve transparency in corporate management as well as to protect the interests of minority shareholders. Class actions under the SRCAA are available in respect of claims arising out of trading in securities issued by companies listed on the Korea Stock Exchange (KSE) or Kosdaq. To qualify as a class action, the action must consist of 50 or more class members holding in aggregate 0.01 percent or more of the issued and outstanding shares of the defendant company, and the claims of the class members must involve common questions of law or fact. Also, the causes of action for a class action are limited to misrepresentations or omissions in securities registration statements or prospectuses, misrepresentations or omissions in periodically filed financial statements, the use of undisclosed information, price manipulation and fraudulent accounting.312

Under South Korea’s 2005 Securities Class Action Law, no attorney may serve as lead counsel or lead plaintiff on a class action suit if he or she has served as lead counsel or lead plaintiff on three or more class action suits in the prior three years.313 This prohibition would seem to discourage attorneys from specializing in bringing class action lawsuits, since they are limited by statute in the number of cases they can bring as lead counsel.314

The first and only reported securities fraud class-action suit was filed in April 2009 by 1700 shareholders against Jinsung, a KOSDAQ-listed maker of machine parts, for losses allegedly caused by accounting fraud. The case settled out of court in January 2010 for approximately $2.5 million.315

311 Stephen J. Choi, The Evidence on Securities Class Actions, University of California At Berkeley School of Law, Public Law and Legal Theory Research Paper Series, 2004.

312 Hyoung Don Kim, Bae Kim & Lee, Seoul, Recent changes to Korean financial law and regulations, iflr1000.com/pdfs/.../5/South%20Korea%20(817-830)%20i.pdf. IFLR1000 is an annual guide to the world’s leading financial and corporate law firms.

313 Dae Hwan Chung, Introduction to South Korea’s New Securities-Related Class Action, 30 IOWA J. CORP. L.165, 171 (2004).

314 Harvard Law School Program on the Legal Profession, Comparative Analyses of Legal Education, Law Firms, and Law and Legal Procedure, The Legal Profession of the Republic of South Korea http://www.law.harvard.edu/programs/plp/pages/comparative_analyses.php and http://www.law.harvard.edu/programs/plp/pdf/Korean_legal_Profession.pdf

315 U.S. Department of State, Bureau of Economic, Energy and Business Affairs, 2011

In 2007 Korea enacted the Financial Investment Services and Capital Markets Act (FSCMA) to replace separate regulations governing securities, derivatives and asset management. Further reforms are underway in hedge funds, private equity funds and other private funds. This Act has been called a deregulatory move that consolidates power of several agencies and laws into one. The law has been repeatedly amended since. The FSCMA repeals the long standing Securities and Exchange Act of 1962 (SECA).316 Many of the same liabilities are found in FSCMA, but with modifications such as those found in the Private Securities Litigation Act of 1994 relating to forward looking statements.317 Other sections of the FSCMA refer back to the old Act as still applying. For example Section 197 of the SECA still applies to auditors. The term “protection of investors” is scattered throughout the Act. However, it appears that Presidential Decree can override that act in many instances “when taking into account the balance between the confidentiality, including corporate management, etc. and the protection of investors.” This exception creates the dangerous possibility of watering down the Act on a whim.

Basics of Filing a Claim and LitigationThe following are the basic steps for filing a claim and litigation:318

• File a written complaint with a district court with the following documents attached: 1) power of attorney properly notarized and translated; and 2) If you and/or Defendant are corporations, commercial registry extracts of Defendant corporation and a “certificate as to corporate nationality,” properly notarized and translated.

• Pay a court stamp fee to file a lawsuit. The amount is usually around 0.5 percent of the claim amount, and you can pay this amount by affixing revenue or payment stamps (a stamp showing the amount you paid to file a lawsuit) in the required amount to the Complaint document.

• If you have no address, office, or other place of business in Korea, the court will order that you provide security for litigation costs, if Defendant requests it. The purpose of this security amount is to secure the Defendant’s claim for reimbursement of the litigation costs expended by Defendant should you lose the case.

Investment Climate Statement—South Korea (March 2011), available at http://www.state.gov/e/eb/rls/othr/ics/2011/157359.htm

316 See Article 2 FSCMA Addenda.317 See Article 162 (Liability for Damages due to Misstatements)318 Hoon Lee, Jipyong & Jipyong , Filing a Lawsuit in Korea: Overview, Korealaw.com

http://www.korealaw.com/sub/information/boardView.asp?brdId=litigation&brdIdx=43&gotopage=1&search=&search_string=



Loser Pay ModelThe basic rule in South Korea is that losing parties (whether plaintiffs or defendants) are compelled to pay the litigation costs for both parties.319 However, the amount that a losing party must reimburse a winning party for legal fees is capped by a formula that depends on the amount of money won in the lawsuit; thus, for lawsuits involving very small sums, a winning party can seek reimbursement for attorneys’ fees not in excess of 8 percent of the amount in controversy, while in very large lawsuits, a winning party can seek reimbursement for attorneys’ fees not in excess of 0.5 percent of the amount in controversy.320 Losing parties are also responsible for paying the filing fees of the winning party. Filing fees are determined based on the amount in controversy; suits with a greater amount in controversy cost more to file, so the fees that must be reimbursed by a losing defendant will rise as the amount in controversy rises.321 A losing party must also pay the winning party’s expenses in collecting evidence.322

Opt-in vs. Opt-outSecurities-related class actions are opt-out. The following is a summary of the procedure:323

• After a complaint is filed with a court, the court should make a public announcement of the lawsuit and, thereafter, approve a lead plaintiff on behalf of the class. If the representative party does not adequately represent the interests of the class as a whole, or should there be any other relevant cause, the court may, according to its authority or on application by the other party, prohibit the furtherance of the suit by the lead plaintiff. Any lead plaintiff or lead counsel who has served as lead plaintiff or lead counsel three or more times in the last three years may not act as lead plaintiff or lead counsel.

• The court must notify individual class members and also publish in a national newspaper any decision to approve a securities-related class action, any modification to the range of class members, any withdrawal of appeal, or any final judgment. Prior to making decisions related to withdrawal of suit, settlement, or relinquishment of a damage claim, the court must notify the class members and provide an opportunity to testify.

• The judgment of the court will bind the lead plaintiff and those who are members of the class, but any class member who wishes to be excluded from the judgment must file a written declaration of exclusion with the court.

319 Gyooho Lee, Cost and Fee Allocation Rules in Korean Civil Procedure, 10 J. KOREAN L. 65, 69 (2010).

320 Id. at 70–71.321 Id. at 72.322 Id. at 73.323 Dae Hwan Chung, Introduction to South Korea’s New Securities-Related Class Action, 30

Iowa J. Corp. L. 165, 171-172 (2004).

• A class member, within the designated period, should report his or her claim with the distributor. Any class member who is not able to report the claim with the distributor within the designated time period may report the claim within one month after the event that caused the failure to report has been concluded, but only if the failure to report is not imputable to the member’s own fault.

Extraterritorial JurisdictionThe Financial Investment Services and Capital Markets Act (FSCMA), which incorporates the old regulations governing securities, derivatives and asset management, including the 1962 Securities and Exchange Act, applies extraterritorially:

Article 2 (Application to Foreign Activities): This Act shall apply to any activity conducted in the foreign jurisdiction where such activity affects the domestic market.

Funding the Litigation —Contingent Fee ArrangementsContingency fee arrangements are allowed and common in civil cases in South Korea, including family law cases.324 They are allowed even in criminal cases, unless the arrangements are judged by the court to be unfair.325 Perhaps because of the low ratio of lawyers-to-population described above, pure contingency fee arrangements are not common; lawyers are usually paid retainer fees before commencing a lawsuit.326 The usual range of contingency fees is between 5 and 10 percent of the amount won or settled for.327

Fraud on the Market TheoryIt appears that reliance is not an element of a claim. But if the person liable proves damages were sustained without regard to the material omission of misstatement, there is no liability.328

324 Gyooho Lee, Cost and Fee Allocation Rules in Korean Civil Procedure, 10 J. KOREAN L. 65, 85 (2010).

325 Id.326 Id.327 Id. at 86.328 See Article 162 FSCMA.



Causes of Action in Securities LitigationUnder the new law, companies listed on the KSE or KOSDAQ, as well as a delineated list of related parties such as directors, auditors, and underwriters, may face a securities class action for, among other things, fraud in a registration statement or prospectus, fraud in an annual, semi-annual, or quarterly report, insider trading, and market manipulation. The new law is patterned somewhat on the U.S. system of class actions, providing for public notice of the class action, court appointment of a lead plaintiff, court certification of the class, and court approval of any settlement arising from the class action.329

Securities-related class actions are limited to the following circumstances:

• falsification of stock certificates, business proposals, business reports, and semi-annual or quarterly reports;

• use of unofficial information for internal trade;

• manipulation of market-conditions; and

• fraudulent audits.330

Article 162 (Liability for Damages due to Misstatements) (1) Any person falling under the following subparagraphs shall be liable for damages where a person who has acquired or disposed of the securities (including securities deposit receipts related to such securities and other securities prescribed by the Presidential Decree; hereafter in this Article, the same shall apply) issued by a reporting corporation sustains damages because an annual report, semi-annual report, quarterly report, or report on material matters (hereinafter referred to as “annual reports, etc.”) under Article 159 (1) and accompanying documents thereof (excluding an audit report prepared by an accounting auditor) contains any misstatement or omission of material matters: Provided, That the same shall not apply to cases where a person who is liable for the compensation proves that he/she could not have known such misstatement or omission despite his/her due diligence, or where the person who has acquired or disposed of such securities knew the fact at the time of the acquisition or disposal: <Amended on Feb. 3, 2009>

329 Young-Cheol Jeong, Securities-Related Class Actions in Korea, International Bar Association Newsletter (2003) (describing aspects of the securities class action bill in Korea).

330 Dae Hwan Chung, Introduction to South Korea’s New Securities-Related Class Action, 30 IOWA J. CORP. L.165, 171-171 (2004).

1. A person who has submitted the annual reports, etc., and directors of the reporting corporation at the time of the submission thereof;

2. A person falling under any subparagraph of Article 401-2 (1) of the Commercial Act, who has instructed to prepare or has been in charge of the annual reports, etc.;

3. A person prescribed by the Presidential Decree as certified public accountant, appraiser, credit-rating specialist, etc. (including any organization to which each of them belongs) who has agreed to prove the authenticity or accuracy of the entries of the annual reports, etc. or accompanying documents thereof and has bore a signature; and

4. A person who has agreed to enter his/her opinion on the assessment, analysis, and confirmation in the entries of the annual reports, etc. and accompanying documents and has verified the entries thereof.

(2) Notwithstanding paragraph (1), any person falling under the subparagraphs of paragraph (1) shall not be liable for damages where forward-looking information is entered or indicated pursuant to each of the following subparagraphs: Provided, That the same shall not apply to cases where the person who has acquired or disposed of the securities concerned has been unaware of the misstatement or omission of material matters at the time of the acquisition and disposal and cases where it has proved that any person falling under each subparagraph of paragraph (1) is responsible for the misstatement or omission by intention or by recklessness:

1. The entry or indication is required to be specified as forward-looking information;

2. The grounds for the assumptions or judgments of the predictions or forecasts are required to be specified;

5. The entry or indication is required to have reasonable grounds or assumptions; and

4. Bespeaks cautions that the projections may differ from the actual result are required to be specified.

(3) The amount to be compensated pursuant to paragraphs (1) and (2) shall be the difference between the amount actually paid or received by the claimant for the acquisition or disposal of the securities concerned and the amount (limited to paragraph (1) in the case of the disposal)falling under either of the following subparagraphs:



1. The market price (where no market price is available, referring to an estimated price at which the securities would be disposed of) of the securities concerned when the argument to make claims for compensation pursuant to paragraphs (1) and (2) is concluded; or

2. Where the disposal is made before the conclusion of the argument under subparagraph 1,the price at which the securities is disposed of.

(4) Notwithstanding paragraph (3), where a person liable for the damages pursuant to paragraphs (1) and (2) proves that a claimant has sustained any or all of the damages without regard to any misstatement or omission of material matters, the person is not bound to compensate for the damages of such part.

(5) The claims for damages under paragraphs (1) and (2) shall be extinguished unless the claimant exercises his/her right of claim within the one year from the date on which he/she has discovered the fact or within the three years from the date when the annual reports, etc. have been submitted.

Regulatory Environment for Securities LitigationThere is a plethora of information on Korea’s securities laws available, including English translations of the laws. During the last decade, Korea has taken to restructuring its financial laws and institutions. Along the way they have added liabilities to market participants, including auditors and financial institutions that audit public companies and sell their securities. Currently, Korean leaders want to build up confidence in Korea’s capital markets and, therefore, an investor could expect support from regulatory agencies.

When the Financial Investment Services and Capital Markets Act (FSCMA) was implemented on February 4, 2009, securities companies under the Securities and Exchange Act, futures companies under the Futures Trading Act, asset management companies, investment advisory companies, and discretionary investment companies under the Act on Business of Operating Indirect Investment and Assets, and trust companies under the Trust Business Act were consolidated into Financial Investment Business Entities under the FSCMA, which governs entry and business activities.331 In addition to the provisions on financial investment businesses, FSCMA provides for disclosure of financial investment instruments

331 Financial Supervisory Service, Financial Supervisory System in Korea, 16 (December 2008).

issuers and the functions and the roles of financial investment entities, such as the KRX and the Korea Financial Investment Association (KFIA), to ensure fair and equitable pricing and trading of financial investment instruments. Companies listed on the KRX are required to file annual and quarterly reports with the FSC/FSS and the KRX as well as ongoing disclosures on any transaction or event that has material impact on their business soundness or financial conditions.332

The Act on External Audit of Stock Companies (AEASC) provides for accounting and auditing regulations. Specifically, AEASC authorizes the FSC/FSS to establish accounting and auditing standards and to enforce filing of financial statements in compliance with the accounting standards and audit in accordance with the auditing standards. AEASC requires auditors to maintain client confidentiality and to report fraud to shareholders. Auditors are liable for any damages caused by negligence in performing audits or failure to disclose material information.333

332 Id at 16-17.333 Id. at 17.



According to the State Department’s 2011 Investment Climate Statement, these new reforms were long due and may not have yet proven effective:

Corporate Governance and Investment Decision-Making: Investors and financial markets remain wary of corporate governance in Korea despite significant improvements since the 1997-98 Asian financial crisis. Concerns about corporate governance often reduce the price/earnings ratios to levels lower than comparable companies elsewhere. Korean policy makers acknowledge that foreign investors often exact a “Korea Discount” when dealing with Korean companies or in making investment decisions. As the Chairman of the Korean Free Trade Commission (KFTC) stated in 2005, “the main reasons for the Korea Discount are opaque accounting techniques, less respect for minority shareholders, insufficient openness and excessive control by controlling families.” Large gaps continue to exist between the ownership and control of a significant number of firms in Korea, with many traditional “chaebol” conglomerates still controlled by their founding families, despite the family’s relatively small ownership stakes. The Korean government is currently implementing an accounting reform plan, taken largely from the U.S. Sarbanes-Oxley Act, aimed at making Korean accounting standards consistent with rigorous international standards. The International Financial

Reporting Standards (K-IFRS) will become Korea’s Generally Accepted Accounting Principles by 2011334

The Financial Supervisory Service, along with delegation to the Securities and Futures Commission supervises, examines and investigates financial institutions upon matters delegated to the Service by the new Financial Services Commission (FSC). More information about the Financial Supervisory Service is available at http://www.fsc.go.kr/eng/.

334 U.S. Department of State, Bureau of Economic, Energy and Business Affairs, 2011 Investment Climate Statement—South Korea (March 2011), available at http://www.state.gov/e/eb/rls/othr/ics/2011/157359.htm



UNITED KINGDOM

OverviewThe United Kingdom does not presently have an American style class action system. There are, however, other methods of multi-party actions available. In England and Wales there are presently two types of collective actions available, including: (1) representative actions and (2) the Group Litigation Order (GLO). Scotland, also a UK jurisdiction, has a different legal system and has not introduced a group action procedure. It will not be addressed in this memo.

Representative actions are the most similar to the American class action. In a representative action, one claimant can represent other parties with the same interest.335 Representative actions, however, are rarely used because they are not available where members of the class have different remedies or defenses.336 Any action where damages must be proved cannot be brought as a representative action. The strict limitations on representative actions led to the development of the GLO mechanism.337

The GLO, introduced in 1999, is a mechanism created by the courts for managing multiple claims “which give rise to common or related issues of fact or law (the ‘GLO issues’).”338 Before the court grants a GLO, it must determine that it will be the most appropriate means of resolving the claims and must establish:

• A group register on which details of the claims to be managed under the GLO must be entered;

• The GLO issues, which will identify the claims to be managed under the GLO; and

• The “management court” responsible for managing the claims.339

335 Civil Procedure Rules, 2012, Part 19.II. (U.K.). 336 Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class &

Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 60 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf

337 Dr. Christopher Hodges, Global Class Actions Project Country Report: England and Wales, 3 (2010), http://globalclassactions.stanford.edu/sites/default/files/documents/England_Country%20Report.pdf

338 Civil Procedure Rules, 2012, Part 19.10. (U.K.).339 Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class &

Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 60 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf

A GLO is not considered a representative action because it covers individual claims. It is possible, however, that a lead case may be selected for decision on a certain issue before other GLO participants.340 So-called “lead actions” allow for a determination of law or fact that can then be applied in other GLO cases to allow the other actions to focus on any remaining individual issues. The rules of estoppel require that any judgment on one GLO issue be binding on all other claims on the group register, unless otherwise ordered by the court.341

There are several steps that must be taken to initiate a GLO. First, either a plaintiff or defendant in a claim may apply to the court for a GLO. The application should summarize the litigation, including the nature and number of claims, parties, and the common issues to the litigation. The applicant should also specify whether there are issues that distinguish any sub-groups. There is no predominance requirement in the GLO criteria, which allows the mechanism to operate as a more flexible case management tool. Once the application is approved, the group is assigned to a judge who has specialized GLO experience. After the GLO has been granted, the judge can order that a group of specific lawyers represent parties in the group so as to ensure more effective coordination. In some of the more complex cases, a “steering group” of lawyers may be appointed.342 There is no oversight by the courts regarding the fairness and reasonableness of settlements.343

GLO proceedings still remain uncommon in England and Wales. A 2011 report found that only 74 GLO actions were pending. Of those, less than ten had been filed in the last five years.344

Loser Pay ModelSimilar to the “loser pay” model, England and Wales follow a “cost shifting” rule that requires the losing party to pay the prevailing party’s court fees and legal costs. Such fees also include costs for expert witnesses and other incidental expenses. It is up to the court to make a determination on the appropriate fees to be paid. In determining the appropriateness of the fees, the court may consider a party’s


341 Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 60 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf

342 Dr. Christopher Hodges, Global Class Actions Project Country Report: England and Wales, 14, 17 (2010), http://globalclassactions.stanford.edu/sites/default/files/documents/England_Country%20Report.pdf

343 Dr. Christopher Hodges, Global Class Actions Project Country Report: England and Wales, 15, 25 (2010), http://globalclassactions.stanford.edu/sites/default/files/documents/England_Country%20Report.pdf




success on a particular issue and/or the parties’ conduct in the litigation. Costs are often significantly discounted upon assessment by the court. Thus, England does not operate under a full “loser pay” model.345

If one party offers a settlement that meets certain requirements, called a “Part 36 offer,” and the opposing party does not accept, the opposing party may be liable for all costs incurred after refusal of the offer unless they receive a better result at trial.

Opt-in vs. Opt-outThe GLO system requires claimants to opt in. It allows for individual claims to be managed together. In order to be coordinated under GLO, a claimant must be named on the group register.346

The UK Government has considered introducing a generic right to a collective action on a sector-specific basis. The only sector-specific rule for litigation currently available is for cases regarding competition laws.347

JurisdictionForeign claimants may bring proceedings in England against English corporations or persons domiciled in England based on conduct in England and the conduct of English subsidiaries outside of the UK. For example, South African citizens successfully brought an action against an affiliate of an English company for exposure to asbestos in South Africa.348

Funding the Litigation- Contingent Fee ArrangementsThere are several options for funding litigation in England. The first option is for the claimants to pay for the litigation themselves, usually at an hourly rate. Because of the cost, this option is not likely to be used in group litigation.349

Legal expense insurance, or Before-The-Event (BTE), has recently become more popular in England. If this method of funding is used, the insurer will usually select the

345 David H. Kistenbroker, Alyx S. Pattison, Patrick M. Smith, Recent Developments in Global Securities Litigation, 1904 PLI Corp. 607, 13 (2011); Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 64 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf



348 Lubbe v. Cape Plc, [2000] 1 WLR 1545; Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 67 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf


lawyer and there will be a financial limit. Such insurance, however, may not cover group cases.350

Another method of funding a case in England is through a conditional fee agreement (CFA). There are generally two types of CFAs: a “no win no fee” agreement and a “less (or nothing) if you lose” agreement.351 An important aspect of the CFAs is that costs recovered against the losing party can be increased in exchange for accepting no fee or a lesser fee if the claim is unsuccessful. CFAs allow for an “uplifted” success fee. The uplifted fee is calculated by using a percentage of the hourly fee. The maximum uplift is 100 percent of the normal hourly fee. Also, the uplift fee should not be greater than 25 percent of the recovered damages.352 Pure American-style contingency fees currently are not permitted in England. In order to protect against the liability of costs of the unsuccessful party, the CFA is usually combined with insurance. If the party is successful, any premiums paid for the insurance will be recoverable as legal costs.353

Fraud on the Market TheoryIn England, claims for deceit and misrepresentation require proof of actual reliance. Accordingly, the doctrine of fraud on the market does not exist.

In bringing a claim for deceit, “[t]he claimant must in fact rely on the statement, as part of which requirement the claimant would have to be aware of the statement. This requirement is taken to rule out the theory of ‘fraud on the market,’ whereby a misstatement which has an effect on the market price can be said to cause an investor loss, even though that particular investor was not aware of the misstatement.”354



352 Alison Brown & Ian Dodds Smith, The International Comparative Legal Guide to: Class & Group Actions 2011: A practical cross-border insight into class and group actions work, Global Legal Group, 66 (2011), http://iclg.co.uk/khadmin/Publications/pdf/3973.pdf; Dr. Christopher Hodges, Global Class Actions Project Country Report: England and Wales, 28 (2010), http://globalclassactions.stanford.edu/sites/default/files/documents/England_Country%20Report.pdf


354 Paul Davies, Davies Review of Issuer Liability: Liability for Misstatements to the Market, 16 (2007), www.treasurers.org/system/files/daviesdiscussion260307.pdf



Pleading StandardsThe English common law system has pleading standards that are relatively similar to the American requirements. Pleadings must contain a “statement . . . of the material facts on which the party pleading relies” and a statement of “the necessary particulars” so as to give the opposing party notice.355 The claimant should also file a summary of the evidence against the defendant.356 When the claimant files a formal petition it must include additional details along with relevant documents. This “statement of the case” is used to provide notice of the issues and allow for orderly and efficient management of the claims.357

Causes of Action in Securities LitigationIn England, securities fraud claims can be made under common law theories including fraud, deceit, and negligent misrepresentation. As discussed above, deceit and misrepresentation claims do not include a fraud on the market theory because they require proof of actual and individual reliance.

Securities claims may also be brought under Section 90 of the Financial Services Markets Act of 2000.358 These claims may be brought for liability based on statements made in a prospectus. Similar to claims brought under Sections 11 and 12 of the Securities Act of 1933, 15 U.S.C. §§77k and l, claims brought under Section 90 of the FSMA do not require proof of reliance or scienter.

Under the U.K Companies Act of 2006, shareholders also may bring derivative suits for breach of duty, breach of trust, and director negligence.359

355 RSC O.18 r. 7(1), r. 12(1) (U.K.).356 Neil Andrews, English Civil Procedure, 254 (2003).357 Scott Dodson, Comparative Convergences in Pleading Standards, 442 Univ. of Pennsylvania

Law Review, Volume 158: 441, 455 (2010).358 Financial Services and Markets Act, 2000, c. 8 § 82-384 (U.K.).359 Companies Act, 2006, c. 46 (U.K); Robert F. Carangelo, Paul A. Ferrillo and Catherine

Y. Nowak, Designing a New Playbook for the New Paradigm: Global Securities Litigation and Regulation, 3 (2011), http://www.weil.com/files/upload/Briefing_Securities_Litigation_111219.pdf.

Regulatory Body for SecuritiesSince the financial crisis, the UK has undergone significant reform of its regulatory bodies. New reforms were published in February 2011 to be overseen by the Financial Policy Committee, the Prudential Regulation Committee and the Financial Conduct Authority. The Financial Policy Committee is assigned to oversee and regulate the entire UK financial system. The Prudential Regulation Committee regulates the financial institutions that carried the greatest balance sheet risk. The Financial Conduct Authority is the successor to the UK Financial Services Authority (“FSA”), which was the UK’s version of the Securities and Exchange Commission.360 According to the reform papers, the goal of the Financial Conduct Authority is to “protect[] and enhance[] the confidence of all consumers of financial services.”361

360 Robert F. Carangelo, Paul A. Ferrillo and Catherine Y. Nowak, Designing a New Playbook for the New Paradigm: Global Securities Litigation and Regulation, 4 (2011), http://www.weil.com/files/upload/Briefing_Securities_Litigation_111219.pdf.

361 HM Treasury, A New Approach to Financial Regulation: Building a Stronger System, at 60 (Feb. 20, 2011).

APPENDIX A: Survey of Money Managers Regarding ADRs


1. What are your general impressions of ADRs?Manager 1: ADRs are a less comprehensive but still useful means for US investors to invest in foreign equities. ADRs are particularly useful for investors who (1) prefer a separate account to a commingled vehicle and (2) choose not to pursue broad country registration and work with custodians experienced in direct foreign investing. Direct investment in foreign equities allows for a greater investment opportunity set, but some investors prefer ADRs for the reasons mentioned.

Manager 2: ADRs can be useful in limited amounts and circumstances.

Manager 3: Favorable way to invest in FX companies.

Manager 4: [Redacted name] actively invests in ADRs for client portfolios. It is the firm’s belief that they are an effective way to access international equity markets.

Manager 5: ADRs enable access to the increasingly global market with the ease of trading on a US exchange.

Manager 6: We recognize that the world is global, therefore our initial screening universe is all stocks and ADRs traded on U.S. exchanges.

Manager 7: We view the fact that ADRs are listed and traded on U.S. exchanges as an equalizer when comparing the viability of ADRs compared to domestically domiciled stocks as potential candidates for investment consideration

Manager 8: We regard ADRs (and we presume you also mean ADSs) as a way to participate in major sector players without having to face foreign accounts, and currency translation challenges and expenses. They also represent a compliance hurdle for the underlying company as they need to meet certain reporting, quality, legal and ethical standards in order to be tradable on the major American exchanges.

2. Which do you prefer, generally: purchasing ADRs when they are available or common shares sold on a foreign exchange?Manager 1: [Redacted name] institutional portfolios generally hold ordinary shares instead of the underlying ADR unless (1) the ADR liquidity is comparable to the ordinary share and/or U.S. trading makes sense from a timing perspective, or (2) there are limitations associated with country registration or the liquidity of the local shares. [Redacted name] traders are very experienced trading foreign equities with trading desks located in key locations around the world. This experience, in our view, creates significant value for our clients.

Manager 2: Generally, we prefer ADRs vs. common shares sold on foreign exchanges because of the logistics in trading foreign shares (fx spots etc.).

Manager 3: ADRs

Manager 4: Many of [Redacted name]’s clients invested in the firm’s International Equity strategy do not have access to global custody, and therefore ADRs are the only practical means by which they can purchase international equities. For clients that do have global custody, the decision to purchase ADRs versus ordinary shares is primarily driven by liquidity. If ample liquidity is available, the firm’s preference would be to purchase ADRs due to the relative simplicity of the transaction.

Manager 5: We only use ADRs and do not use ordinaries on a foreign exchange. We prefer SEC oversight. Trading on a U.S. exchange dramatically reduces costs for both us and our clients. Using foreign common stocks requires additional portfolio accounting modules, currency accounting, additional pricing source, and corporate action support. In regards to trading, a global trading platform, global settlements and perhaps an additional trader would be needed to cover different time zones. For our clients, custodial fees may be increased for global accounting, currency and settlement for each foreign market.

Manager 6: Per our guidelines, we only purchase securities denominated in USD, therefore we only purchase ADRs.

Manager 7: We are a domestic large cap growth equity manager and as such we will occasionally own an ADR but common shares sold on a foreign exchange are not eligible investment candidates for our portfolios.

Manager 8: ADRs – see above for the reasons.



3. Do your clients prefer holding common shares issued by a foreign company or ADRs purchased in the U.S.?Manager 1: ADRs are useful for clients with the constraints discussed in item 1. However, clients who are not constrained in the manner discussed generally prefer ordinary shares.

Manager 2: We’ve found that most clients prefer ADRs for the same reasons as given in the previous answer.

Manager 3: ADRs

Manager 4: Many of [redacted name]’s clients invested in the firm’s International Equity strategy do not have access to global custody and therefore prefer ADRs.

Manager 5: As a domestic manager, we generally do not have full knowledge of our clients’ international preferences. All of our clients, except those prohibited by law, have agreed to the use of ADRs in the portfolio we manage on their behalf.

Manager 6: N/A

Manager 7: Foreign common shares are not eligible investment candidates for our portfolios; therefore, we are not in a position to be knowledgeable regarding our clients’ general preferences related to foreign security holdings.

Manager 8: Not sure but we do communicate our reasons to them.

4. Does the type of ADR (Level I, II, or III) affect your decision to purchase ADRs over common shares? (Is your purchasing decision affected by whether the ADR is sold on a US exchange or in the OTC market?)Manager 1: [Redacted name] institutional portfolios absent client constraints with respect to direct investing in foreign equities generally purchase ordinary shares. If an ADR is purchased it is only for the reasons described above. ADR liquidity (and not an explicit level I II or III designation) is the key consideration and this does not precisely coincide with whether or not the ADR is trading on a U.S. exchange or the OTC market.

Manager 2: We only purchase ADRs listed on US exchanges, which would exclude Level I. Typically, we invest in Level II ADRs.

Manager 3: No.

Manager 4: The primary factor affecting the decision to purchase ADRs over common shares is whether or not a client has global custody and the liquidity of the securities being considered for purchase. While most of the ADRs bought for client portfolios are traded on US exchanges, [redacted name] does also purchase different levels of sponsored and unsponsored ADRs, some of which are traded on the OTC market.

As of March 9, 2012, the portfolio of a representative account in the [redacted name] International Equity strategy contains the following ADR components as a percentage of the total market value of the portfolio: Listed ADRs (traded on NYSE): 25.33 percent; Unlisted ADRs (traded on the OTC markets): 8.22 percent.

Manager 5: No, it does not affect the purchase decision.

Manager 6: Yes, we only buy ADRs sold on US exchanges. Many of our clients have guidelines restricting us from making purchases OTC.

Manager 7: Historically, we have only owned ADRs traded on an US exchange.

Manager 8: Yes – quality, ease of trading.

5. Are there any functional differences between ADRs and foreign common shares that influence your purchasing decisions?Manager 1: As stated above, we always prefer ordinary shares when possible unless liquidity or local registration makes an ADR equally, if not more, compelling.

Manager 2: ADRs are logistically more efficient.

Manager 3: No.

Manager 4: The primary factor affecting the decision to purchase ADRs over common shares is whether or not a client has global custody and the liquidity of the securities being considered for purchase. For clients that do have global custody, the decision to purchase ADRs versus ordinary shares is primarily driven by liquidity. If ample liquidity is available, the firm’s preference would be to purchase ADRs due to the relative simplicity of the transaction.

Manager 5: Yes, please see the answer to question 2.



Manager 6: N/A

Manager 7: Foreign common shares are not eligible investment candidates for our portfolios; therefore, we are not able to give a qualified answer to this question.

Manager 8: Yes – see question 1.

6. What are the advantages or disadvantages to purchasing ADRs over foreign common shares?Manager 1: ADRs offer the opportunity to invest in foreign companies without country registration and cross-border registration/administrative concerns. Foreign common shares, however, offer a broader investment opportunity set and often superior liquidity.

Manager 2: Answered above

Manager 3: Ease of use. FX based shares can cause custodians headaches…in dealing with dividends, buys/sells and settling in FX currency.3

Manager 4: The primary advantage of purchasing ADRs over foreign common shares is that ADRs are a more cost effective way to invest in international equities as global custody/trading is not required. Furthermore, for exchange-listed ADRs, the companies must file with the SEC. This can provide an extra degree of transparency to the investor that may not be available if the company were operating in a country with less strict disclosure requirements. ADR’s also trade during New York market hours while ordinary shares may trade at odd hours, depending on the time zones in which the foreign exchanges operate. While [redacted name] feels there are sufficient ADRs available to effectively manage international equity portfolios, ADRs are not available for all foreign companies so the opportunity set for an ADR-only portfolio is somewhat smaller. In addition, while the performance of ADRs closely tracks that of the underlying companies’ ordinary shares, there can be minor differences in returns over the short term. However, potential to arbitrage eliminates disparities over time.

Manager 5: ADRs provide access to global securities while avoiding the costs and administrative work that is required when purchasing common shares as outlined in question two. The disadvantage may be that the ADR is removed from the local currency.

Manager 6:

Advantages:

1. Access to exposures that we cannot get in U.S market

2. They are treated like US stocks in that they trade during US market hours, are quoted in USD, have the same settlement rules and dividends are paid in USD

3. No need to have country specific accounts and deal with the complications of international trading and settlement

Disadvantages:

1.Applied currency risk

2. Some countries have dividend hold backs

3. There is limited selection as not all foreign companies have available ADRs

4. Often less liquid than their local shares

Manager 7: As a domestic large cap growth manager, denomination of ADRs in US dollar removes the currency translation /exchange element of transacting in these securities. Listing of ADRs on US exchanges also removes any complexities related to foreign exchange listing. However, we only occasionally have any ADR exposure in our large cap growth portfolio and it will be because a specific candidate happens to be an ADR by incorporation, not because we are specifically trying to achieve foreign stock exposure.

Manager 8: Please see question 1.

7. What is your opinion of the ADR market? Are ADRs available for enough companies? Manager 1: Many stocks in [redacted name] institutional portfolios are not available in ADR form. ADRs are a useful tool, but, for clients with the flexibility to invest in foreign equities directly, a portfolio limited to ADRs would offer relatively fewer investment opportunities. We can build ADR only portfolios for clients and we offer commingled retail and institutional portfolios for clients wishing to invest in foreign equities directly without registration and administrative concerns. We also offer institutional separate account portfolios for clients such as the [redacted name] that allow for direct foreign investing, but still provide the client with the flexibility to dictate other special preferences with respect to their portfolio (e.g. a limitation of emerging markets exposure and other



special limitations with respect to avoiding companies with interests in Sudan).

Manager 2: Answered above

Manager 3: Favorable, and yes, for our style.

Manager 4: It is the firm’s belief that ADRs are an effective way to access international equity markets. WHV feels there is a sufficient universe of ADRs available to effectively manage a portfolio of international equities.

Manager 5: The ADR market is relatively thin; more should be available

Manager 6: In our experience, generally speaking ADRs are only available in sufficient liquidity for large well-known companies in international markets.

Manager 7: As a domestic manager, we only occasionally have any ADR exposure within the portfolio and typically it is for all practical purposes a US company that has incorporated elsewhere for tax purposes. Thus ADRs are not a class of stocks we evaluate or target specifically.

Manager 8: There are a few major global companies that I am still hoping will go through the ADR process.

8. What problems, if any, do you see with the market for ADRs? Manager 1: ADRs are not available for many foreign companies, and when available they do not always trade with comparable or in some cases even sufficient liquidity.

Manager 2: N/A

Manager 3: No significant problems.

Manager 4: While [redacted name] feels there are sufficient ADRs available to effectively manage international equity portfolios, ADRs are not available for all companies so the opportunity set for an ADR-only portfolio is somewhat smaller. In addition, while the performance of ADRs closely tracks that of the underlying companies’ ordinary shares, there can be minor differences in returns over the short term. However, potential to arbitrage eliminates disparities over time.

Manager 5: The ADR market is relatively thin; more should be available

Manager 6: The primary issue is liquidity; to effectively trade them one often needs to access the local market and

convert shares. Once the local market closes, liquidity is generally meaningfully less.

Manager 7: We do not trade in ADRs enough to give a qualified answer to this question.

Manager 8: Some say that recent US regulatory changes made an already top notch set of standards a little too stringent for some companies which have since dropped ADR representation. It would be a shame if an attempt at perfection damaged a good system.

9. Would the protections of the U.S. securities laws influence your decision to purchase ADRs over common shares from a foreign exchange? (Would you purchase ADRs instead of common shares on a foreign exchange because they are protected under the U.S. securities laws?)Manager 1: If the quality of the underlying investment is questionable based on our in-depth fundamental analysis, the ADR listing would be insufficient reason to own the security. Our investment approach is driven by bottom-up stock selection where understanding the fundamentals of the company are essential. Our analysts are also assigned complementary country coverage which provides additional information, including foreign securities laws, to analysts in order to keep them apprised of the risks and opportunities that could impact specific stock analysis. Our traders are also extremely well versed on the nuances of trading directly in foreign markets. This multi-faceted global approach, supported by decades of experience in foreign investing is applies for every security held in [redacted name] portfolios.

Manager 2: We only purchase securities that are denominated in U.S. dollars and traded on US exchanges

Manager 3: Yes, slightly. However, our firm rarely deals in securities where there is “Country Risk”….i.e., China, India, Russia and other emerging economies….we primarily invest in developed countries such as Canada, Australia, Great Britain, Switzerland…etc.

Manager 4: For exchange-listed, sponsored Level II and III ADRs, protections of U.S. securities laws may provide an extra degree of transparency that may not be available if the company were operating in a country with less strict disclosure requirements. All else being equal, the firm’s



preference would be to purchase ADRs over ordinary shares due to the relative simplicity of the transaction.

Manager 5: Yes, protection under US law is a positive.

Manager 6: No, as our guidelines would prevent us from doing so.

Manager 7: Protection under US securities laws would likely be advantageous but does not factor into our research as common shares on a foreign exchange are not eligible investment candidates for our portfolios.

Manager 8: See questions 1 and 8

10. Please add any comment concerning the subject matter of this survey. We only purchase securities that are denominated in U.S. dollars and traded on U.S. exchanges.

[Redacted name] actively invests in ADRs for client portfolios. It is the firm’s belief that they are an effective way to access international equity markets.

APPENDIX B: Interview of Colorado PERA’s Director of Equities regarding ADRs


In June 2012, Adam L. Franklin, Esq., conducted an interview/survey of Colorado PERA’s Director of Equities, Jim Liptak, regarding ADRs. The questions posed, along with Mr. Liptak’s answers, are as follows:

1. If an institutional investor wanted to protect itself from the effects of Morrison by only investing in ADRs, would that be possible and what effects might that decision have on the portfolio?If Colorado PERA chose to purchase only ADRs rather than directly purchasing shares on a foreign exchange, it would have a significant impact on our portfolio’s composition and potentially could negatively impact our investment results. A small percentage of companies that are in our global equity benchmark have liquid ADRs available for purchase, so we would be unable to invest in a large portion of the non-U.S. investable universe. Limiting the eligible investment universe negatively impacts our ability to generate excess investment returns over the long-term.

2. What are some of the reasons an institutional investor may choose to invest in an ADR versus purchasing the common stock on a foreign exchange?When Colorado PERA directly invests in non-U.S. equities, we evaluate the benefits of foreign share versus ADR ownership, as applicable. Considerations usually center on liquidity and the availability of investment alternatives. We generally purchase ADRs when it would be difficult to purchase shares in the local market and/or the ADRs have favorable liquidity. Some foreign markets have very strict requirements regarding their local currency as well as the account(s) that must be set up and maintained to make such purchases. In these situations where the market is difficult to trade efficiently, the ADR might be the more liquid option. It is worth noting that many U.S. investment firms are not allowed to invest directly in local shares of non-U.S. companies. In addition, some firms might not have the infrastructure to trade foreign equities and currencies. Therefore, ADRs are the main way for these firms to gain exposure to non-U.S. companies.

3. What are some of the reasons that an institutional investor might choose not to invest in an ADR even if it is available?In many cases the local shares are more liquid than the ADR, and increased liquidity generally means a more favorable execution and therefore lower trading and transaction costs. For example, if you own an illiquid ADR and need to sell it, you will either be forced to hold onto it longer before you can sell at a reasonable price (thereby increasing risk), or you will have to sell it at a lower price in order to execute the transaction. If it is possible to own the more liquid local shares of a company, then we would choose to do so due to the lower cost associated with transacting in that security.

4. In light of Morrison, why would a foreign company choose to offer ADRs when they could avoid the U.S. securities laws by only selling common shares on a foreign exchange?When foreign companies need to raise capital they might choose to offer company sponsored ADRs in the U.S., which will increase their investor base while adding to the overall liquidity of all of the company’s tradable equity. It may also lower the company’s overall cost of capital, which can help a company improve its profitability. In some situations, the foreign company recognizes that it is too difficult for foreign investors to enter their local market, so they may be able to raise more capital if they go outside their local market to offer ADRs in the U.S. Although companies may consider the incremental U.S. legal risk in offering ADRs, it is probably not material enough to offset the potential benefits of lowering the company’s cost of capital and expanding its investor base.

APPENDIX C


Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the

Securities Exchange Act of 1934 As Required by Section 929Y of the

Dodd-Frank Wall Street Reform and Consumer Protection Act

Study by the Staff of theU.S. Securities and Exchange Commission

April 2012

This study has been prepared by the Staff of the U.S. Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings, or conclusions contained herein.

APPENDIX C


i

Executive Summary

Introduction

This study stems from two significant legal developments in the Summer of 2010 regarding the application of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) to transnational securities frauds. Section 10(b) is an antifraud provision designed to combat a wide variety of manipulative and deceptive activities that can occur in connection with the purchase or sale of a security. The Securities and Exchange Commission (“Commission”) has civil enforcement authority under Section 10(b) and the Department of Justice (“DOJ”) has criminal enforcement authority. Further, injured investors can pursue a private right of action under Section 10(b); meritorious private actions have long been recognized as an important supplement to civil and criminal law-enforcement actions.

On June 24, 2010, the Supreme Court in Morrison v. National Australia Bank concluded that there is no “affirmative indication” in the Exchange Act that Section 10(b) applies extraterritorially. Finding no affirmative indication of an extraterritorial reach, the Supreme Court adopted a new transactional test under which:

Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.

Congress promptly responded to the Morrison decision by adding Section 929P(b)(2) of Title IXof the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). Section 929P(b)(2) provided the necessary affirmative indication of extraterritoriality for Section 10(b) actions involving transnational securities frauds brought by the Commission and DOJ. Specifically, Section 929P(b)(2) provides the district courts of the United States with jurisdiction over Commission and DOJ enforcement actions if the fraud involves:

(1) conduct within the United States that constitutes a significant step in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or

(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.

With respect to private actions under Section 10(b), Section 929Y of the Dodd-Frank Act directed the Commission to solicit public comment and then conduct a study to consider the extension of the cross-border scope of private actions in a similar fashion, or in some narrower manner. Additionally, Section 929Y provided that the study shall consider and analyze the potential implications on international comity and the potential economic costs and benefits of extending the cross-border scope of private actions.

APPENDIX C


ii

Background

Conduct and Effects Tests. Prior to the Supreme Court’s Morrison decision, the lower federal courts had applied two tests to determine the cross-border reach of Section 10(b): the conduct test and the effects test.

Under the conduct test, Section 10(b) applied if a sufficient level of conduct comprising the transnational fraud occurred in the United States, even if the victims or the purchases and sales were overseas. Although the courts had adopted a range of approaches to defining when the level of domestic conduct was sufficient, courts generally found the conduct test satisfied where: (1) the mastermind of the fraud operated from the United States in a scheme to sell shares in a foreign entity to overseas investors; (2) much of the important efforts such as the underwriting, drafting of prospectuses, and accounting work that led to the fraudulent offering of a U.S. issuer’s securities to overseas investors occurred in the United States; or (3) the United States was used as a base of operations for meetings, phone calls, and bank accounts to receive overseas investors’ funds.

Under the effects test, Section 10(b) applied to transnational securities frauds when conduct occurring in foreign countries caused foreseeable and substantial harm to U.S. interests.Among other situations, the effects test applied where either overseas fraudulent conduct or a predominantly foreign transaction resulted in a direct injury to: (1) investors resident in the United States (even if the U.S. investors are relatively small in number); (2) securities traded on a U.S. exchange or otherwise issued by a U.S. entity; or (3) U.S. domestic markets, at least where a reasonably particularized harm occurred.

Morrison Litigation. Morrison involved a so-called “foreign-cubed” class action – aclass action on behalf of foreign investors who had acquired the common stock of a foreign corporation through purchases effected on foreign securities exchanges. The plaintiffs alleged that the foreign corporation made false and misleading statements outside the United States to the plaintiff-investors that were based on false financial figures that had been generated in the United States by a wholly-owned U.S. subsidiary. The federal district court dismissed the case,holding that the conduct test had not been satisfied. The court of appeals affirmed the dismissal.

At the Supreme Court, many of the arguments raised by the parties and the various amicicuriae (i.e., non-parties who voluntarily submitted their views and analysis to assist the Court) centered on policy arguments supporting or opposing the conduct and effects tests in comparison to a bright-line test that would restrict the cross-border reach of Section 10(b).

The plaintiffs and their supporting amici argued, among other things, that: (1) there is an inherent U.S. interest in ensuring that even foreign purchasers of globally traded securities are not defrauded, because the prices that they pay for their securities will ultimately impact the prices at which the securities are sold in the United States; (2) foreign issuers that cross-list in the United States benefit from the prestige and increased investor confidence that results from a U.S. listing, and thus it is reasonable to hold these foreign issuers to the full force of the U.S. securities laws regardless of where the particular transaction occurs; (3) without the cross-borderapplication of Section 10(b) afforded by the conduct and effects tests, there generally would be

APPENDIX C


iii

no legal options for redress open to the foreign victims of frauds committed by persons residing in the United States; and (4) eliminating the conduct and effects tests could be a significant factor weighing against further or continued foreign investment in the United States.

The defendants and their supporting amici (excluding foreign governments) argued, among other things, that: (1) the uncertainty and lack of predictability resulting from the conduct and effects tests discourage investment in the United States and capital raising in the United States, which would not occur with a bright-line test limiting Section 10(b) only to transactions within the United States; (2) application of Section 10(b) private liability to frauds resulting in transactions on foreign exchanges would result in wasteful and abusive litigation, cause the United States to become a leading venue for global securities class actions, and subject foreign issuers to the burdens and uncertainty of extensive U.S. discovery, pre-trial litigation, and perhaps trial before plaintiffs’ claims can be dismissed under the conduct and effects tests; and (3) different nations have reached different conclusions about what constitutes fraud, how to deter it, and when to prosecute it, and the cross-border application of U.S. securities law would interfere with those sovereign policy choices.

The U.S. Solicitor General, joined by the Commission, recommended to the Supreme Court a standard that would permit a private plaintiff who suffered a loss overseas as part of a transnational securities fraud to pursue redress under Section 10(b) if the U.S. component of the fraud directly caused the plaintiff’s injury. Although the Solicitor General acknowledged the potential for private securities actions brought under U.S. law to conflict with the procedures and remedies afforded by foreign nations, the Solicitor General opposed a transactional test that would permit a Section 10(b) private action only if the securities transaction occurred in the United States. A transactional test, the Solicitor General explained, would produce arbitrary outcomes, including denying a Section 10(b) private action even when the fraud was hatched and executed entirely in the United States and the injured investors were in the United States if the transactions induced by the fraud were executed abroad.

The British, French, and Australian Governments opposed to varying degrees the cross-border scope of private rights of action under Section 10(b). Each argued that it had made different policy choices about the prevention of fraud and enforcement of antifraud rules based on its own sovereign interests, and asserted that each choice deserved respect. The British and French Governments expressly supported a bright-line test.

Morrison Decision. As noted above, the Supreme Court adopted a new transactional test under which Section 10(b) applies only to frauds in connection with the “the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” In rejecting the conduct and effects tests, the Court expressly identified the potential threat of regulatory conflict and international discord that private securities class actions can pose in the context of transnational securities frauds. Justice Stevens filed a concurrence in which he argued in favor of the conduct and effects tests, and criticized the transactional test as unduly excluding from private redress under Section 10(b) frauds that transpire in the United States or directly target U.S. citizens.

APPENDIX C


iv

Post-Morrison Legal Developments

Following the Morrison decision, the lower federal courts have addressed a number of questions regarding the interpretation and application of the transactional test. To date, the courts have issued decisions holding that:

1) Although the Supreme Court stated in Morrison that Section 10(b) applies to the “purchase or sale of a security listed on an American stock exchange,” an investor in a U.S. and foreign cross-listed security cannot maintain a Section 10(b) private action if he or she acquired the security on the foreign stock exchange.

2) An investor who acquires an exchange-traded American depositaryreceipt (ADR), which is a type of security that represents an ownership interest in a specified amount of a foreign security, can maintain a Section 10(b) private action.

3) The purchase or sale of a security on a foreign exchange by a U.S. investor is not within the reach of Section 10(b) even if the transaction was initiated in the United States (e.g., the purchase or sale order was placed with a U.S. broker-dealer by a U.S. investor).

4) A Section 10(b) private action is not available for a U.S. counter-party to a security-based swap that references a foreign security, at least to the extent that the counter-party is suing a third party (i.e., a non-party to the swap) for fraudulent conduct related to the foreign-referenced security.

5) Section 10(b) applies where a defendant engages in insider trading overseas with respect to a U.S. exchange-traded corporation by acquiring contracts for difference, which are a type of security in which the purchaser acquires the future movement of the underlying company’s common stock without taking formal ownership of the company’s shares.

6) A Section 10(b) private action is not available against a securities intermediary such as a broker-dealer, investment adviser, or underwriter if the transaction for which the investor suffered a loss occurred on a foreign exchange or otherwise outside the United States, even if (i) the intermediary resided in the United States and primarily engaged in the fraudulent conduct here, or (ii) the intermediary traveled to the United States frequently to meet with the U.S. investor-client.

7) Investors who purchase shares of an off-shore feeder fund that holds itself out as investing exclusively or predominantly in a U.S. fund cannot maintain a Section 10(b) private action unless the purchase of the feederfund’s shares occurred in the United States.

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Courts are divided on the issue of how to determine whether a purchase or sale of securities not listed on a U.S. or foreign exchange takes place in the United States, setting forth a number of competing approaches that include looking to: (a) whether either the offer or the acceptance of the off-exchange transaction occurred in the United States; (b) whether the event resulting in “irrevocable liability” occurred in the United States; or (c) whether the issuance of the securities occurred in the United States.

Responses to Request for Public Comment

In response to the Commission’s request for public comments, as of January 1, 2012 the Commission received 72 comment letters (excluding duplicate and follow-up letters) – 30 from institutional investors; 19 from law firms and accounting firms; 8 from foreign governments; 7from public companies and associations representing them; 7 from academics; and 1 from an individual investor. Of these, 44 supported enactment of the conduct and effects tests or some modified version of the tests, while 23 supported retention of the Morrison transactional test.

Arguments in Favor of the Transactional Test. The comment letters in support of the transactional test asserted that cross-border extension of Section 10(b) private actions would create significant conflicts with other nations’ laws, interfere with the important and legitimate policy choices that these nations have made, and result in wasteful and abusive litigation involving transactions that occur on foreign securities exchanges. Those comment letters argue that, by contrast, retention of the transactional test would foster market growth because the test provides a bright-line standard for issuers to reasonably predict their liability exposure in private Section 10(b) actions.

Arguments Against the Transactional Test. The comment letters opposed to the transactional test argued, among other things, that: whether an exchange-traded securities transaction executed through a broker-dealer occurs in the United States or overseas may not be either apparent to U.S. investors or within their control; the transactional test impairs the ability of U.S. investment funds to achieve a diversified portfolio that includes foreign securities because the funds will have to either trade in the less liquid and potentially more costly ADRmarket in the United States or, alternatively, forgo Section 10(b) private remedies to trade overseas or pursue foreign litigation; and the transactional test fails to provide a private action in situations where U.S. investors are induced within the United States to purchase securities overseas.

Arguments in Favor of the Conducts and Effects Tests. The comment letters supporting enactment of the conduct and effects tests argued that doing so would promote investor protection because private actions would be available to supplement Commission enforcement actions involving transnational securities frauds. These comment letters also argued that the conduct and effects tests reflect the economic reality that although a company’s shares may trade on a foreign exchange and the company may be incorporated overseas, the entity may have an extensive U.S. presence justifying application of U.S. securities laws. Further, comment letters also argued that the conduct and effects tests ensure that fraudsters operating in the United States or targeting investors in the United States cannot easily avoid the reach of Section 10(b) private

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liability, and facilitates international comity by balancing the interests of the United States and foreign jurisdictions.

Arguments Against the Conduct and Effects Tests. The arguments against the conduct and effects tests largely mirrored those set forth above in favor of the transactional test. In addition, these comment letters argued that: investor protection and deterrence of fraud are sufficiently achieved in the context of transnational securities fraud by Congress having enacted the conduct and effects tests for cases brought by the Commission and DOJ; small U.S. investors do not need the heightened protection of the conduct and effects tests because they generally do not directly invest overseas; the conduct and effects tests’ fact-specific analysis bears little relationship to investors’ expectations about whether they are protected by U.S. securities laws; and foreign legal regimes already provide sufficient remedies for investors who engage in transactions abroad.

Alternative Approaches that Commenters Proposed. Several comment letters argued in support of conduct and effects tests limited to U.S. resident investors. According to these comment letters, such an approach would minimize many of the international comity concerns associated with the conduct and effects tests because foreign nations recognize that the United States has a strong interest in protecting its own citizens.

Another option that the comment letters suggested was a fraud-in-the-inducement standard under which an investor could maintain a Section 10(b) private action if the investor was induced to purchase or sell the security in reliance on materially false or misleading material provided to the investor in the United States. Comment letters supporting this alternative argued that it would be consistent with investors’ expectations, because investors generally believe that they will be protected by the legal regime that applies in the locations where they are subjected to fraudulent information or conduct.

Options Regarding the Cross-Border Reach of Section 10(b) Private Actions

The Staff advances the following options for consideration:

Options Regarding the Conduct and Effects Tests. Enactment of conduct and effects testsfor Section 10(b) private actions similar to the test enacted for Commission and DOJ enforcement actions is one potential option. Consideration might also be given to alternative approaches focusing on narrowing the conduct test’s scope to ameliorate those concerns that have been voiced about the negative consequences of a broad conduct test. One such approach (which the Solicitor General and the Commission recommended in the Morrison litigation) would be to require the plaintiff to demonstrate that the plaintiff’s injury resulted directly from conduct within the United States. Among other things, requiring private plaintiffs to establish that their losses were a direct result of conduct in the United States could mitigate the risk ofpotential conflict with foreign nations’ laws by limiting the availability of a Section 10(b) private remedy to situations in which the domestic conduct is closely linked to the overseas injury. The Commission has not altered its view in support of this standard.

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Another option is to enact conduct and effects tests only for U.S. resident investors. Such an approach could limit the potential conflict between U.S. and foreign law, while still potentially furthering two of the principal regulatory interests of the U.S. securities laws – i.e.,protection of U.S. investors and U.S. markets.

Options to Supplement and Clarify the Transactional Test. In addition to possible enactment of some form of conduct and effects tests, the Study sets forth four options for consideration to supplement and clarify the transactional test. One option is to permit investors to pursue a Section 10(b) private action for the purchase or sale of any security that is of the same class of securities registered in the United States, irrespective of the actual location of the transaction. A second option, which is not exclusive of other options, is to authorize Section 10(b) private actions against securities intermediaries such as broker-dealers and investment advisers that engage in securities fraud while purchasing or selling securities overseas for U.S. investors or providing other services related to overseas securities transactions to U.S. investors.A third option is to permit investors to pursue a Section 10(b) private action if they can demonstrate that they were fraudulently induced while in the United States to engage in the transaction, irrespective of where the actual transaction takes place. A final option is to clarify that an off-exchange transaction takes place in the United States if either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the United States.

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Table of Contents

I. Introduction..........................................................................................................................5

A. Study’s Genesis........................................................................................................5

B. Study’s Mandate ......................................................................................................6

C. Study’s Scope...........................................................................................................8

II. Background ..........................................................................................................................9

A. International Comity ................................................................................................9

B. Conduct and Effects Tests .....................................................................................10

C. Morrison Litigation................................................................................................13

1. Lower Court Litigation ..............................................................................13

2. Supreme Court Briefing.............................................................................16

a. The Parties’ Arguments .................................................................16

b. Views Expressed in Amicus Curiae Briefs Supporting Plaintiffs.........................................................................................18

c. Views Expressed in Amicus Curiae Briefs Supporting Defendants (Excluding Foreign Governments’ Briefs) ................20

d. United States Government’s Views ...............................................22

e. Views Expressed by Foreign Governments ...................................23

3. The Supreme Court’s Decision in Morrison..............................................25

III. Application of the Transactional Test: Issues Addressed in Post-Morrison Decisions............................................................................................................................28

A. Is the “Purchase or Sale of a Security Listed on an American Exchange” Prong of the Transactional Test Satisfied if a Transaction Involves a Security that Is “Listed” on a U.S. Securities Exchange, or Must the Actual Transaction that Resulted in the Investor’s Loss Have Occurred on the U.S. Exchange? ........29

B. Are Purchases and Sales of American Depositary Receipts Covered by Section 10(b)? ...................................................................................................30

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C. How does the Transactional Test Apply to “Foreign-Squared” Cases – i.e., U.S. Investors Purchasing Foreign Securities on a Foreign Exchange? ......32

D. When Does a Purchase or Sale of Securities not Listed on a U.S. orForeign Exchange Take Place in the United States? .............................................33

E. How Does the Transactional Test Apply When the Fraudulent Conduct Is Not Engaged in by the Issuer of the Security, but Rather by Intermediaries such as Investment Advisers, Broker-Dealers, or Underwriters? ....................................................................................................35

F. How Does the Transactional Test Apply to Security-Based Swap Transactions that Reference a Security Traded on a Foreign Exchange? .............36

G. How Does the Transactional Test Apply When an Individual Engages in Insider Trading with Respect to a U.S. Listed Company by Purchasing Derivatives Overseas that Reference the U.S. Security? .......................................38

H. How Is the Purchase of Shares in an Off-Shore Feeder Fund that Itself Invests in a U.S. Fund Treated Under the Transactional Test? .............................38

IV. Responses to Request for Public Comment .......................................................................39

A. Overview................................................................................................................39

B. Comments Concerning the Morrison Transactional Test ......................................40

1. Arguments in Favor of the Transactional Test ..........................................40

2. Arguments Against the Transactional Test................................................42

a. Whether an Exchange-Traded Securities Transaction Occurs in the United States or Overseas May Not Be Apparent to Investors. ....................................................................42

b. Transactional Test Impairs the Ability of U.S. Investment Funds to Achieve a Diversified Investment Portfolio. ........................................................................................45

c. Transactional Test Forecloses Private Actions Involving Foreign Transactions in U.S.-Listed Securities........................................................................................47

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d. Transactional Test Fails to Account for Situations When U.S. Investors Are Induced to Purchase Securities Overseas. ........................................................................................48

C. Comments Concerning the Conduct and Effects Tests..........................................49

1. Arguments in Favor of the Conduct and Effects Tests ..............................49

a. Conduct and Effects Tests Better Serve Investor Protection and Improve Investor Confidence in the U.S. Securities Market. .........................................................................49

b. Conduct and Effects Tests Reflect the Realities of Modern Global Business Organizations and Finance. ...................50

c. Conduct and Effects Tests Ensure that Fraudsters Either Operating in the United States or Targeting the United States Cannot Avoid the Reach of the U.S. Securities Laws Simply by Arranging for the Securities Transaction to Occur Overseas. .....................................................51

d. Conduct and Effects Tests Do Not Harm International Comity. ....................................................................52

2. Arguments Against the Conduct and Effects Tests ...................................53

D. Alternative Approaches Proposed by Commenters ...............................................55

1. Adoption of Conduct and Effects Tests that Are Limited To U.S. Resident Investors......................................................................................55

2. Adoption of a Fraud-in-the-Inducement Test ............................................57

V. Options to Extend the Section 10(b) Private Action Extraterritorially..............................58

A. Options Regarding the Conduct and Effects Tests ................................................60

B. Options to Supplement and Clarify the Transactional Test ...................................64

1. Permit Investors to Pursue a Section 10(b) Private Action for the Purchase or Sale of any Security that Is of the Same Class of Securities Registered in the United States, Irrespective of the Actual Location of the Transaction......................................................64

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2. Authorize Section 10(b) Private Actions Against Securities Intermediaries that Engage in Securities Fraud While Purchasing or Selling Securities Overseas for U.S. Investors ...................66

3. Permit Investors to Pursue a Section 10(b) Private Action if They Can Demonstrate that They Were Induced While in the United States to Engage in the Transaction, Irrespective of Where the Actual Transaction Occurred ....................................................67

4. Clarify that an Off-Exchange Transaction Takes Place in the United States if Either Party Made the Offer to Sell or Purchase, or Accepted the Offer to Sell or Purchase, While in the United States ........................................................................................68

VI. Conclusion .........................................................................................................................69

Bibliography ..................................................................................................................................71

Appendix A: Regulatory Framework for American Depositary Receipts ................................... A1

Appendix B: Economic Research on the Costs and Benefits of Extending a Private Right of Action for Transnational Securities Frauds ............................... B1

APPENDIX C


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I. Introduction

A. Study’s Genesis

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”). Section 929Y of Title IX of the Dodd-Frank Act (“Dodd-Frank Section 929Y”) requires the Securities and Exchange Commission to conduct a study regarding whether and to what extent the private right of action under Section 10(b) of the Exchange Act should be extended to transnational securities frauds involving the purchase and sale of a security that occurs outside the United States (“Study”).1 (The Study refers to this interchangeably as the “extraterritorial extension” or “cross-border extension” of the Section 10(b) private right of action). It has long been recognized that meritorious private litigation under the federal securities laws is an important tool to combat securities fraud, particularly given the limited resources available to the Commission.2

1 Section 10(b) of the Exchange Act provides that:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange –

* * *

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section

206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the

Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

15 U.S.C. § 78j(b).

2 See, e.g., Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 313 (2007) (meritorious private actions to enforce federal antifraud securities laws are an essential supplement to criminal prosecutions and civil enforcement actions); J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964) (private rights of action under the securities laws are a “necessary supplement” to Commission actions). But see Tellabs, 551 U.S. at 313 (cautioning that private securities fraud actions, if not adequately contained, can be employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law); Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 80 (2006) (observing that the Court had previously noted that private Section 10(b) litigation presents a danger of vexatiousness different in degree and in kind from that which accompanies litigation in general).

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Congress commissioned this Study in response to the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd.,3 in which the Court significantly limited the cross-border scope of Section 10(b) of the Exchange Act. Morrison held that:

Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.4

The Morrison decision rejected four decades of federal court of appeals’ precedents that had allowed Section 10(b) actions involving transnational securities frauds either when the fraud involved significant conduct within the United States causing injury to overseas investors, or substantial foreseeable effects occurring to investors or markets within the United States.

B. Study’s Mandate

In Section 929P(b)(2) of the Dodd-Frank Act, Congress restored the ability of the Securities and Exchange Commission (“Commission”) and the Department of Justice (“DOJ”) to bring enforcement actions under Section 10(b) in cases involving transnational securities fraud.5

3 130 S. Ct. 2869 (2010).

4 Id. at 2888. See also id. at 2884 (“[I]t is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which §10(b) applies.”).

5 With respect to Commission and DOJ actions under Section 10(b), Dodd-Frank Act Section 929P(b)(2) codified the pre-Morrison view that the extraterritoriality inquiry is one of subject matter jurisdiction by adding the following provision to Section 27 of the Exchange Act:

(b) EXTRATERRITORIAL JURISDICTION. – The district courts of the United States and the United States courts of any Territory shall have jurisdiction of an action or proceeding brought or instituted by the

Commission or the United States alleging a violation of the antifraud provisions of this title involving –

(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or


See 156 Cong. Rec. H5237 (daily ed. June 30, 2010) (statement of Rep. Kanjorski, author of Section 929P(b)) (“In the case of Morrison v. National Australia Bank, the Supreme Court last week held that section 10(b) of the Exchange Act applies only to transactions in securities listed

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Section 929Y(a) of the Dodd-Frank Act directs the Commission to conduct a study to determinewhether private rights of action under Section 10(b) should be similarly extended. Specifically, the Commission is directed to solicit public comment and then undertake a study considering whether private actions under Section 10(b) should be extended to reach:

(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or


Section 929Y(b) provides that the Study shall consider and analyze, among other things:

• the scope of such a private right of action, including whether it should extend to all private actors or whether it should be more limited to extend just to institutional investors or otherwise;

• what implications such a private right of action would have on international comity;6

• the economic costs and benefits of extending a private right of action for transnational securities frauds; and

• whether a narrower extraterritorial standard [than was enacted for the Commission and the DOJ] should be adopted [for private actions].

These considerations are addressed below. Section 929Y(c) requires that the Study be submitted to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives.

on United States exchanges and transactions in other securities that occur in the United States. In this case, the Court also said that it was applying a presumption against extraterritoriality. This bill’s provisions concerning extraterritoriality, however, are intended to rebut that presumption by clearly indicating that Congress intends extraterritorial application in cases brought by the SEC or the Justice Department. Thus, the purpose of the language of section 929P(b) of the bill is to make clear that in actions and proceedings brought by the SEC or the Justice Department, the specified provisions of the Securities Act, the Exchange Act and theInvestment Advisers Act may have extraterritorial application, and that extraterritorial application is appropriate, irrespective of whether the securities are traded on a domestic exchange or the transactions occur in the United States, when the conduct within the United States is significant or when conduct outside the United States has a foreseeable substantial effect within the United States.”). See also 156 Cong. Rec. S5915-16 (daily ed. July 15, 2010) (statement of Senator Reed).

6 See discussion in Section II.A, infra.

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C. Study’s Scope

Given the multitude of issues to be considered, a cross-Divisional staff working group (“Staff”) was formed to undertake the Study. Staff participants included representatives from the:

Office of the General Counsel; Office of International Affairs;

Division of Corporation Finance; Division of Enforcement; and

Division of Risk, Strategy, and Financial Innovation.

The Staff also consulted during the course of the Study with staff from the Office of Investor Education and Advocacy, the Division of Investment Management, and the Division of Trading and Markets.

On October 25, 2010, the Commission issued a release that was subsequently published in the Federal Register inviting public comment on the four statutory issues identified above. The release also encouraged commenters to discuss, among other things:

• the circumstances, if any, in which a private plaintiff should be allowed to pursue claims even though the plaintiff purchased or sold the security outside the United States, and whether it makes a difference if: (a) the security was issued by a U.S. company or a non-U.S. company; (b) the security was purchased or sold on a foreign stock exchange, or purchased or sold on a non-exchange trading platform; or (c) the company’s securities are traded exclusively outside the United States;

• the degree to which investors know, at the time that they place a securities purchase or sale order, whether the order will take place on a foreign stock exchange or on a non-exchange trading platform or other alternative trading system outside of the United States;

• any cases that have been dismissed as a result of Morrison or pending cases in which a challenge based on Morrison has been filed;

• remedies available outside the United States to U.S. investors who purchase or sell shares on a foreign stock exchange, or on a non-exchange trading platform or other alternative trading system outside of the United States; and

• the potential impact of the extraterritorial application of the private right of action on: (a) investor protection; (b) the maintenance of fair, orderly, and efficient markets; and (c) the facilitation of capital formation.

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The Commission received 72 public comment letters as of January 1, 2012, including letters from investors and investor organizations, business associations, foreign government authorities, law firms, accounting firms, and academics. The Staff has carefully considered the views of these commenters and has incorporated them in the Study.

To help further inform the Study, when requested by outside parties, the Staff met with interested parties representing a variety of perspectives beginning in the Spring of 2011. These included meetings with representatives from investor protection associations, business associations, foreign institutional investors, and U.S. public pension funds. In addition, members of the Staff participated in a conference on the extraterritorial application of the federal securities laws that was hosted by the American Law Institute in Washington, D.C.7 Conference participants included federal and state judges, lawyers from the plaintiff and defense bar, representatives from foreign governments, and academics.

II. Background

A. International Comity

Because much of the discussion concerning the cross-border scope of the Section 10(b) private right of action implicates considerations of international comity, a brief overview of the concept is appropriate.8

International comity is a customary international-law principle involving respect for the validity and effect of nations’ executive, legislative, and judicial determinations.9 The United States has recognized the principle of international comity as part of U.S. law.10 Consistent with international comity, U.S. courts and government agencies often attempt, where possible, to balance the public and private interests of the United States with the competing policies of foreign jurisdictions when a conflict arises between U.S. and foreign law.11

7 A video of the American Law Institute conference is available at the following internet address: http://www.ali.org/index.cfm?fuseaction=meetings.videos&video=1. 8 A number of the amicus briefs and comment letters described in the Study raised arguments related to international comity. See Section II.C.2 and Section IV.B, infra.

9 See Hilton v. Guyot, 159 U.S. 113, 143 (1895) (explaining that international comity is “the recognition which one nation allows within its territory to the legislative, executive or judicial acts of another nation, having due regard both to international duty and convenience, and to the rights of its own citizens or of other persons who are under the protection of its laws”). See generally EXTRATERRITORIAL JURISDICTION IN THEORY AND PRACTICE (Karl M. Meessen ed., 1996).

10 Hilton, 159 U.S. at 143.

11 See generally Joel R. Paul, The Transformation of International Comity, 71 LAW &CONTEMP. PROBS. 19 (2008).

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International comity is frequently implicated in the context of transnational securities frauds, particularly given that issuers and investors may be located in multiple jurisdictions, and various parts of their securities transactions may occur in each of these jurisdictions.12 In these situations, it is often the case that each of the jurisdictions may have an interest in applying itslegal regime to the fraudulent conduct. International comity requires each jurisdiction to recognize the laws and interests of the other jurisdictions with respect to persons and activities outside its territory, and thus helps ameliorate potential conflicts among the jurisdictions.13

B. Conduct and Effects Tests

Prior to the adoption of Section 929P(b)(2) of the Dodd-Frank Act,14 the Exchange Act did not explicitly define the circumstances under which Section 10(b) applied to securities frauds that took place in whole or in part outside the United States.15 In the absence of clear Congressional guidance, the courts faced with transnational fraud issues had attempted “[t]o discern ‘whether Congress would have wished the precious resources of the United States courts and law enforcement agencies to be devoted’” to transnational securities frauds.16 The courts acknowledged that the inquiry was largely guided by “policy considerations and the court’s best judgment.”17

The consensus view among the courts that considered the issue was that Congress would not have wanted wrongdoers offshore to be free to cause harm in the United States, or for the United States to be used as a base for fraudulent schemes directed at foreigners, even if the actual transaction affected by the fraud took place overseas. Consequently, the courts applied two tests to determine the reach of the antifraud provisions: the conduct test and the effects test.18 These tests were based on generally recognized principles of international law.19

12 See generally Kellye Y. Testy, Comity and Cooperation: Securities Regulation in a Global Marketplace, 45 ALA. L. REV. 927 (1994). 13 RESTATEMENT (THIRD) OF FOREIGN RELATIONS LAW OF THE UNITED STATES (1987)(hereinafter “RESTATEMENT OF FOREIGN RELATIONS”) Part IV, Chapter 1, Subchapter A, Introduction (“International law has long recognized limitations on the authority of states to exercise jurisdiction to prescribe in circumstances affecting the interests of other states.”).

14 See supra note 4.

15 See Itoba Ltd. v. LEP Group PLC, 54 F.3d 118, 121 (2d Cir. 1995).

16 Europe and Overseas Commodity Traders, S.A. v. Banque Paribas London, 147 F.3d 118, 125 (2d Cir. 1998) (quoting Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 985 (2d Cir. 1975)).

17 Kauthar SDN BHD v. Sternberg, 149 F.3d 659, 664 (7th Cir. 1998).

18 See, e.g., Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir. 1991); Itoba Ltd., 54 F.3d at 121-22. Courts also applied an admixture of the two tests. See generally Dennis R. Dumas, United

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The conduct test focused “on the nature of [the] conduct within the United States as itrelates to carrying out the alleged fraudulent scheme,”20 on the theory that “Congress would not want the United States to become a base for fraudulent activity harming foreign investors.”21

This test held that sufficient conduct in the United States violated Section 10(b) even if the victims or the purchases and sales were overseas.

The courts had adopted a range of approaches to defining when the level of domestic conduct was sufficient. On one end of the spectrum, the D.C. Circuit Court of Appeals required that the domestic conduct at issue must itself constitute a securities violation.22 On the other end of the spectrum, three courts of appeals required only “some activity” in the United States that was “significant” to the furtherance of the fraudulent scheme.23 Although it was difficult to know what differences in phraseology meant in practice, three other courts of appeals defined the test in terms that seemed to rest somewhere between the two extremes, not requiring that all of the violative conduct occur in the United States as under the D.C. Circuit standard, but requiring more U.S. conduct that had a larger role in the scheme than the courts requiring only “some activity” that was “significant” to the scheme. For example, the Seventh Circuit Court of Appeals explained that this intermediate standard permitted a Section 10(b) action to proceed when the conduct “forms a substantial part of the alleged fraud and is material to its success.”24

States Antifraud Jurisdiction Over Transnational Securities Transactions: Merger of the Conduct and Effects Tests, 16 U. PA. J. INT’L BUS. L. 721 (1995).

19 See generally RESTATEMENT OF FOREIGN RELATIONS § 402, supra note 13 (stating that the United States has authority to prescribe law with respect to, among other things, (i) “conduct that, wholly or in substantial part, takes place within its territory,” and (ii) “conduct outside its territory that has or is intended to have substantial effect within its territory”). 20 Psimenos v. E.F. Hutton & Co., 722 F.2d 1041, 1045 (2d Cir. 1983).

21 Banque Paribas, 147 F.3d at 125.

22 See Zoelsch v. Arthur Andersen & Co., 824 F.2d 27, 31 (D.C. Cir. 1987) (“[J]urisdiction will lie in American courts where the domestic conduct comprises all the elements of a defendant’s conduct necessary to establish [a violation of the antifraud provisions].”).

23 See, e.g., Grunenthal GmbH v. Hotz, 712 F.2d 421, 425 (9th Cir. 1983); Continental Grain (Australia) Pty. Ltd. v. Pacific Oilseeds, Inc., 592 F.2d 409, 421 (8th Cir. 1979); SEC v. Kasser, 548 F.2d 109 (3d Cir. 1977).

24 Kauthar, 149 F.3d at 667. See also, e.g., Robinson v. TCI/US West Communications Inc.,117 F.3d 900, 905 & n.10 (5th Cir. 1997) (domestic conduct must be “material” and “substantial”); Psimenos, 722 F.2d at 1045 (2d Cir.) (domestic conduct must be “material” and “substantial”).

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Notwithstanding the competing formulations, the conduct test as applied had a broad reach that led to the application of Section 10(b) to a variety of transnational securities fraud schemes with roots in the United States – many of which did not involve domestic transactions.These included securities frauds where: (1) the mastermind of the fraud operated from the United States in a scheme to sell shares in a foreign entity to overseas investors;25 (2) much of the important efforts such as the underwriting, drafting of prospectuses, and accounting work that led to the fraudulent offering of a U.S. issuer’s securities to overseas investors occurred in the United States;26 or (3) the United States was used as a base of operations for meetings, phone calls, and bank accounts to receive overseas investors’ funds.27

Under the effects test, Section 10(b) applied to transnational securities frauds when conduct occurring in foreign countries “caused foreseeable and substantial harm to interests in the United States.”28 This approach was generally consistent with the principle that acts done outside a jurisdiction, but that are either intended to produce, threaten to produce, or foreseeably do produce detrimental effects within its jurisdiction, justify a state in punishing the harm as if the actor had been present in the jurisdiction.29

25 See SEC v. Berger, 322 F.3d 187 (2d Cir. 2003) (applying Section 10(b) to a U.S. resident who operated an investment company organized under the laws of the British Virgin Islands that was held almost entirely by foreigners).

Among other situations, the effects test applied when either overseas fraudulent conduct or a predominately foreign transaction resulted in harmto: (1) investors resident in the United States (even if the U.S. investors were relatively small in

26 See IIT v. Cornfeld, 619 F.2d 909 (2d Cir. 1980) (applying Section 10(b) where overseas offering was in essence an offering of securities of an American issuer that was closely coordinated with a United States offering of securities in the same issuer, and where much of the critical efforts in making the offering occurred in the United States, and little of importance happened overseas).

27 Kauthar, 149 F.3d at 667.

28 Mak v. Wocom Commodities Ltd., 112 F.3d 287, 289 (7th Cir. 1997) (quoting Tamari v. Bache & Co. (Lebanon) S.A.L., 730 F.2d 1103, 1108 (7th Cir. 1984)). See also Banque Paribas London, 147 F.3d at 125. See also Interbrew S.A. v. Edperbrascan Corp., 23 F. Supp. 2d 425, 430 (S.D.N.Y. 1998).

29 See Schoenbaum, 405 F.2d at 206. Presumably because it focused on domestic injuries for which the United States has long been viewed as having a strong sovereign interest in redressing, the effects test appears to have been relatively uncontroversial. See generally Strassheim v. Daily, 221 U.S. 280, 285 (1911) (“Acts done outside a jurisdiction, but intended to produce and producing detrimental effects within it, justify a State punishing the cause of the harm as if he had been present at the effect ….”).

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number);30 (2) securities either traded on a U.S. exchange or issued by a U.S. entity;31 or (3) U.S. domestic markets, at least where a reasonably particularized harm occurred.32

C. Morrison Litigation

1. Lower Court Litigation

Morrison v. National Australia Bank involved a so-called “foreign-cubed” class action –foreign plaintiffs suing a foreign issuer concerning securities transactions that occurred on a foreign exchange.33 Specifically, the case was a putative class action on behalf of persons who had acquired National Australia Bank’s (NAB) common stock on foreign securities exchanges during a two-year period beginning in mid-1999. Plaintiffs alleged that NAB – a large Australian bank whose stock principally trades on the Australian Securities Exchange34

30 See, e.g., Consolidated Gold Fields PLC v. Minorco, S.A., 871 F.2d 252, 262-63 (2d Cir.), amended on other grounds, 890 F.2d 569 (2d Cir. 1989); Bersch, 519 F.2d at 991; E.ON AG v. Acciona, S.A., 468 F. Supp. 2d 537, 546-48 (S.D.N.Y. 2006). Cf. Banque Paribas, 147 F.3d at 128 n.12 (“U.S. residence of individual investors – not American nationality – must be the focus of the effects test.”).

– made

31 See, e.g., Des Brisay v. Goldfield Corp., 549 F.2d 133, 134-36 (9th Cir. 1977). See also Schoenbaum v. Firstbrook, 405 F.2d 200, 206 (2d Cir. 1968), modified on other grounds, 405 F.2d 215 (1968) (en banc) (“protect[s] the domestic securities market from the effects of improper foreign transactions in American securities”).

32 Cf. Mak v. Wocom Commodities Ltd., 112 F.3d 287, 290 (7th Cir. 1997).

33 Generally speaking, foreign-cubed class actions were perhaps one of the most controversial Section 10(b) private actions pursued under the conduct and effects tests because, to many courts and commentators, the cases seemed to have relatively little connection to the United States. See generally John C. Coffee, Jr., Foreign Issuers Fear Global Class Actions,NAT’L L.J. (June 14, 2007). But see generally Peter M. Saparoff & Katharine C. Beattie, The Benefits of Including Foreign Investors in U.S. Securities Class Action Suits, SN084 A.L.I.-A.B.A. 669 (2008) (arguing that “U.S. courts should include [foreign-cubed plaintiffs] in class actions for three overarching reasons: (1) the U.S. class action is the superior method for resolving global securities fraud cases; (2) including foreign investors will promote securities fraud settlements and deter future fraud; and (3) including foreign purchasers will encourage cooperation on the global regulatory front”).

34 A small percentage of NAB’s equity traded on the New York Stock Exchange in the form of American Depositary Receipts (ADRs), but none of the remaining class members involved in the suit on appeal had purchased these instruments. See generally discussion of ADRs in Appendix A, infra.

NAB first listed its ADRs on the New York Stock Exchange (“NYSE”) on June 24, 1988, at the same time registering its securities with the Commission (which, as discussed in Appendix

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false and misleading statements overseas to the class members concerning the profitability of a wholly-owned U.S. subsidiary. NAB’s overseas public statements were allegedly based on false financial figures that the subsidiary’s executives knowingly generated in the United States in order to inflate the subsidiary’s value, and then sent to Australia for incorporation in NAB’s consolidated financials. When the fraud was revealed, the price of NAB’s shares dropped significantly, causing losses to the class members. Plaintiffs filed suit in a U.S. district court against NAB, its subsidiary, and certain senior officials, alleging violations of Section 10(b) of the Exchange Act and Rule 10b-5.35

A, the Commission requires in order to list ADRs on a U.S. stock exchange). At that time, shares of NAB also traded on the Australian Stock Exchange, London Stock Exchange, Tokyo Stock Exchange, and New Zealand Stock Exchange. Over the next several years, NAB made regular filings and submissions of its annual report and additional reports on Form 6-K (report of information that the foreign issuer (i) makes or is required to make public pursuant to the law of the jurisdiction of its domicile or in which it is incorporated or organized, or (ii) files or is required to file with a stock exchange on which its securities are traded and which was made public by that exchange, or (iii) distributes or is required to distribute to its security holders). From time to time, NAB registered equity and debt securities for sale under the Securities Act in connection with capital raising transactions and employee benefit plans. NAB delisted its ADRs from the NYSE on June 18, 2007, and NAB filed a Form 15F to terminate its registration and reporting obligations under the Exchange Act on June 21, 2007. NAB’s ADRs continue to trade in the United States over-the-counter.

35 Rule 10b-5, which the Commission promulgated pursuant to its rulemaking authority under Section 10(b) of the Exchange Act, prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security. The rule provides that:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

Exchange Act Rule 10b-5, 17 C.F.R. § 240.10b-5.

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The district court dismissed the case, holding that the foreign plaintiffs’ claims did not satisfy the conduct test.36 In analyzing the allegations under the conduct test, the district court determined that “a significant, if not predominant, amount of the material conduct in this case occurred a half-world away.”37 As the district court saw it, the U.S. subsidiary’s conduct “amounts to, at most, a link in the chain of an alleged overall securities fraud scheme that culminated abroad,” and, thus, “[o]n balance, it is the foreign acts – not any domestic ones – that ‘directly caused’ the alleged harm here.”38

The Second Circuit Court of Appeals affirmed the dismissal. The court found that the conduct and effects tests were not satisfied given “the fact that the fraudulent statements at issue emanated from NAB’s corporate headquarters in Australia, the complete lack of any effect on America or Americans, and the lengthy chain of causation between [the subsidiary’s] actions and the statements that reached investors.”39

Notwithstanding its holding in favor of NAB, the court declined NAB’s broader invitation to “jettison[] [the] conduct and effects tests” in favor of a “bright-line” standard.40

First, the court did not agree with NAB that a bright-line standard was necessary to reduce potential conflicts between U.S. antifraud laws and those of foreign nations, explaining that “[i]four anti-fraud laws are stricter than [a foreign state’s], that country will surely not be offended by their application.”41 Second, the court expressed concern that a bright-line standard “would conflict with the goal of preventing the export of fraud from America” and ensuring that the United States is not “seen as a safe haven for securities cheaters.”42 Third, the court stated that it is “leery of rigid bright-line rules because [it] cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result in their being subject to American jurisdiction.”43

36 In re National Australia Bank Securities Litig., No. 03-6537, 2006 WL 3844465, at *2-8(S.D.N.Y. Oct. 25, 2006).

Lastly, the court reasoned that the conduct and effects tests adequately ensure that U.S. courts are not converted to “the world’s court” for securities fraud, or that U.S.

37 Id. at *7.

38 Id. at *8.

39 547 F.3d 167, 177 (2d Cir. 2008).

40 Id. at 175.

41 Id. (quoting IIT v. Cornfeld, 619 F.2d 909, 921 (2d Cir. 1980) (Friendly, J.) (internal quotation marks omitted)).

42 Id.

43 Id.

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judicial resources are expended “resolving cases that do not affect Americans or involve fraud emanating from America.”44

2. Supreme Court Briefing

a. The Parties’ Arguments

In their merits briefs before the Supreme Court, the plaintiffs argued that Section 10(b) affords a private action for victims of transnational securities frauds if the conduct in the United States both is material to the fraud’s success and forms a substantial component of the fraudulent scheme.45 According to plaintiffs,

The materiality inquiry would ensure that the domestic conduct was an integral link in the chain of events in the transnational fraud leading to the foreign investors’ losses. The substantiality showing would generally be satisfied by demonstrating that a sufficient quantum of conduct occurred in the United States reasonably to warrant application of the Exchange Act.46

Plaintiffs asserted that this standard would not cause significant conflicts with other nations’ laws because the potential for such conflict is much less where enforcement of the antifraud sections of the securities laws is concerned.47 Moreover, the material-and-substantialstandard would “permit the courts to make flexible case-by-case determinations of the extraterritorial applicability of the antifraud provisions of the Exchange Act, insuring that the interests of comity will be furthered and not offended by each application.”48

The defendants argued that the conduct and effects tests should be rejected as contravening the presumption that a statute only applies domestically unless there is a clear indication that Congress intended otherwise.49 The defendants argued instead for a bright-line bar on private actions under Section 10(b) for frauds in connection with a transaction on a foreign securities exchange.50

44 Id.

In support, they asserted that the extension of the Section 10(b)

45 Brief for Petitioners, at 31 (Jan. 19, 2010) (available at 2010 WL 265632). The formulation offered by the plaintiffs largely reflected the intermediate version of the conduct test as set forth by the Courts of Appeals for the Second, Fifth, and Seventh Circuits. See generallycases cited in footnote 24, supra.

46 Id. at 32.

47 Id. at 35-38.

48 Id. at 40.

49 Brief for Respondents, at 32-39 (Feb. 19, 2010) (available at 2010 WL 665167). 50 Id. at 43-44.

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private right of action to securities transactions outside the United States would create significant conflicts with other nations’ laws, cataloguing dozens of potential conflicts, and argued that the United States should not interfere with other nations’ sovereign policy choices on these issues. 51

51 See id. at 47-48. The defendants identified the following potential conflicts:

What are the duties of disclosure? What information is material? Should forward-looking statements be allowed, and, if so, with what restrictions or protections? How is fraud to be redressed? Should public enforcement be supplemented with private lawsuits at all? If so, what are the elements of a claim? What state of mind is required to establish liability? Must a plaintiff show reliance? If so, how? Should a “fraud-on-the-market” presumption of reliance be recognized? … Should there be issuer liability for secondary trading at all – that is, should an issuer, and by extension its current shareholders, pay damages for losses suffered by shareholders who did not buy their shares from the company, but from other shareholders on the open market? What is the test for causation? How are damages measured? Should there be a cap on class damages? Should there be a “lookback” limit on recoverable losses, limiting damages on the basisof an upswing in a security’s price after it drops? Who can be sued? Control persons? Secondary actors? Should class actions be allowed? Opt-out? Or opt-in? Should losers pay the winners’ attorneys’ fees? Should contingency fees be allowed?

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b. Views Expressed in Amicus Curiae Briefs Supporting Plaintiffs

The amicus curiae briefs submitted in support of the plaintiffs identified a number of concerns with a rule that would reject the conduct and effects tests in favor of defendants’ proposed transactional test.52 One set of concerns related to securities that are listed on both U.S. and foreign exchanges. Certain of the plaintiffs’ amici asserted that it “makes little sense to apply a rule that artificially seeks to sever purchases abroad from purchases within the territorial United States.”53 As they explained, securities prices are set by information and trading that “transcends national boundaries,” and thus “there is an inherent American interest in ensuring that even foreign purchasers are not defrauded, because the prices they pay for their securities will ultimately impact the prices at which securities are sold in America.”54

Relatedly, plaintiffs’ amici argued that foreign issuers that cross-list in the United States benefit from the prestige and increased investor confidence that results from the U.S. listing, and thus it is reasonable to hold these foreign issuers to the full force of the U.S. securities laws regardless of where the particular transaction occurs.55 “By voluntarily listing its securities on an American exchange and filing reports with the SEC, a foreign issuer signals to global investors its willingness to comply with – and be bound by – the U.S. law’s disclosure and liability provisions. That willingness translates into greater liquidity and higher prices for [the foreign issuer’s] shares, whether they be the U.S.-listed [American Depositary Receipts56] or common stock traded on [a] non-U.S. exchange.”57

52 An amicus curiae is a non-party to a legal proceeding who volunteers to offer information, analysis or views – often in the form of a legal brief – to assist a court in deciding an issue before it. The phrase “amicus curiae” means “friend of the court.”

53 Brief for Alecta Pensionsförsäkring, Ömsesidigt, AmpegaGerling Investment GmbH, APG Algemene Pensioen Groep N.V., et al., at 25 (Jan. 26, 2010) (available at 2010 WL 342027).

54 Id. at 23.

55 See generally discussion of “bonding hypothesis” in Appendix B, infra. 56 See generally discussion in Appendix A, infra.

57 Brief for MN Services Vermogensbeheer B.V., Scottish Widows Investment Partnership Limited, and North Yorkshire Pension Fund, at 9 (Jan. 26, 2010) (available at 2010 WL 342029). See also Brief for the Australian Shareholders’ Association and the Australian Council of Super Investors, at 9 (Jan. 26, 2010) (available at 2010 WL 342028) (hereinafter Brief for the Australian Shareholders, et al.”) (“[W]hen the economy is global, and truly ‘international’ companies trade their stock over securities exchanges throughout the world, it is essential for the optimal functioning of national and international securities markets that foreign investors are afforded the protection of laws such as the anti-fraud provisions of the Securities Exchange Act of 1934.”) (emphasis in original).

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Beyond situations involving cross-listing, plaintiffs’ amici argued that the existence of substantial fraudulent conduct in the United States that is targeted overseas should be sufficient to allow foreign investors to sue under Section 10(b). They argued that, without the extraterritorial application of Section 10(b) afforded by the conduct and effects tests, there would generally be no legal options for redress open to the foreign victims of frauds committed by persons residing in the United States.58 As a result, “perpetrators of securities fraud within the United States [would be] able to ‘export’ the consequences of their misdeeds with little or no riskof being held responsible.”59 Plaintiffs’ amici argued that this would “do considerable damage to the standing of the United States in investors’ minds,”60 and could “lead to United States citizens lacking similar protections for their own foreign investments.”61 They warned thateliminating the conduct and effects tests could also become “a significant factor weighing against further or continued foreign investment in the United States.”62 According to plaintiffs’ amici, “[i]f foreign investors believe that they cannot trust the securities issued by corporations with a substantial American presence – because the American portion of the business may not be subject to stringent antifraud regulation – those investors will hesitate to risk their capital on such securities.”63

58 Brief for the Australian Shareholders, et al., at 6 (“Where the party committing a fraud resides in the United States, there are generally few or no legal options open to the foreign victims of that fraud to seek redress other than those provided under the United States legal system.”). In advancing this argument, plaintiffs’ amici did not specify whether the lack of a legal option for redress would result from the difficulty of a foreign court obtaining jurisdiction over the U.S. person who committed the fraud, from limitations on private redress under foreign law, or from other factors.

59 Id. at 5.

60 Id. at 7.

61 Id. at 8.

62 Id. at 11

63 Brief for Alecta Pensionsförsäkring, Ömsesidigt, AmpegaGerling Investment GmbH, APG Algemene Pensioen Groep N.V., et al., at 34-35. But see generally economic analysis set forth in Appendix B, infra.

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c. Views Expressed in Amicus Curiae Briefs Supporting Defendants (Excluding Foreign Governments’ Briefs)

Defendants’ amici generally argued in favor of a bright-line standard that, at a minimum, would eliminate Section 10(b) private actions for foreign-cubed class actions.64

A principal argument advanced in support of such an approach concerned the importance of predictability in encouraging domestic investment and raising capital.65 “The absence of a clear standard leaves open the risk for non-U.S. entities that engaging in investment activity in the United States – be it direct investment, such as acquiring a U.S. subsidiary, or raising capital in U.S. markets – will give rise to liability for claims under an expansive Section 10(b) implied right of action as applied to securities issued abroad under other regulatory regimes.”66

64 As an alternative, one amicus curiae brief proposed a “bright-line rule restricting the fraud-on-the-market doctrine to domestic exchanges.” Brief for Professors and Students of the Yale Law School Capital Markets and Financial Investments Clinic, at 3 (Feb. 26, 2010) (available at 2010 WL 748251). Under the fraud-on-the-market doctrine, an investor need not establish individualized reliance on a defendant’s misrepresentations or omissions, but instead may rely on a presumption that “the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.” Basic Inc. v. Levinson, 485 U.S. 224, 246 (1988). The amicus brief argued that application of the fraud-on-the-market theory to foreign exchanges poses international comity concerns because: (1) “almost all other jurisdictions reject that doctrine,” and (2) it would require an assessment of a foreign nation’s regulatory regime as part of the overall determination of whether the stocks traded in an efficient market. Brief for Professors and Students of the Yale Law School Capital Markets and Financial Investments Clinic, at 8 & 12-13 (emphasis in original).

By

65 Cf. Brief for NYSE Euronext, at 11 (Feb. 26, 2010) (available at 2010 WL 723008) (asserting that a bright-line rule that excludes transactions by foreign investors on foreign exchanges from private redress under Section 10(b) would also be consistent with the reasonable expectations of these investors because investors “make investment decisions based on the laws and regulations in the countries where they purchase securities”).

66 Brief for the Securities Industry and Financial Markets Association, the Association for Financial Markets in Europe, the Chamber of Commerce of the United States of America, the United States Council for International Business, the Association Française des Entreprises Privées, and GC100, at 8-9 (Feb. 26, 2010) (available at 2010 WL 723005) (hereinafter “Brief for SIFMA et al.”). See also Brief for Washington Legal Foundation, at 19 (Feb. 26, 2010) (available at 2010 WL 723011) (“Subjecting a company to a United States securities class action, even where it sells no securities in the United States, on the basis of conduct at a United States subsidiary or division, would increase the risk of investing in the subsidiary or division in the first place.”); Brief for Infineon Technologies AG at 27 (Feb. 26, 2010) (available at 2010 WL 723007) (stating that foreign issuers may be discouraged from listing a portion of their securitieson a U.S. exchange because the financial risk of “global class actions by foreign investors who have no connection with the United States often vastly exceeds the value of such listings”).

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contrast, a bright-line standard that eliminated private liability under Section 10(b) for transactions in foreign securities that occur on foreign exchanges would “foster[] capital-raising activities” because a foreign issuer “would be able to reasonably predict the scope of potential liability in the U.S. as a result of its listing” some fraction of its shares in the United States – i.e.,“liability would be limited to the universe of investors who chose to purchase the issuer’s securities on the U.S. exchange.”67 According to defendants’ amici, this would allow the issuer to “adjust[] the size of its issuance in proportion to its choice of risk.”68

As an additional policy basis supporting a bright-line standard, defendants’ amici argued that extending Section 10(b) private liability to frauds in connection with transactions on foreign exchanges would result in wasteful and abusive litigation. They warned that the United States could become a venue for global securities class actions, which would “burden[] the already overtaxed district courts and divert[] precious judicial resources to redress harms having nothing to do with United States markets or United States investors.”69 This, they explained, is in part because global securities class actions “present challenges” in both “managing discovery where a substantial part of the evidence and parties reside outside the United States” and administering the class (including providing notice to class members) “when most of the class members reside in other countries.”70 From the foreign issuers’ perspective, this means they would “often be subjected to the burdens and uncertainty of intensive U.S. discovery, pre-trial litigation, and perhaps trial before plaintiffs’ claims can be ruled out-of-bounds as improperly extraterritorial and by that time much harm to the foreign issuer will have been done.”71

Finally, echoing the defendants’ brief, defendants’ amici argued that “different nations have reached different conclusions about what constitutes fraud and how to deter and prosecute it,” and the “[e]xtraterritorial application of U.S. securities law necessarily risks interfering with the authority of other sovereign nations to make these policy choices.” 72

67 Brief for NYSE Euronext, at 5-6.

The threats to

68 Id. at 5-6.

69 Brief for Washington Legal Foundation, at 17. See also Brief for Law Professors, at 28 (Feb. 26, 2010) (available at 2010 WL 740747).

70 Brief for Washington Legal Foundation, at 19.

71 Brief for the Institute of International Bankers, European Banking Federation, and the Australian Bankers’ Association, at 28 (Feb. 26, 2010) (available at 2010 WL 723004) (hereinafter “Brief for International Bankers, et al.”). See also Brief for the International Chamber of Commerce, the Swiss Bankers Association, Economiesuisse, the Federation of German Industries and the French Business Confederation, at 7 (Feb. 26, 2010) (available at 2010 WL 719334).

72 Brief for International Bankers, et al., at 18-19. See, e.g., Brief for SIFMA et al. at 26 (“conflict with the careful policy judgments made by other nations”); Brief for the European Aeronautic Defence & Space Co. N.V., Alstom SA, Lagardère Groupe SCA, Thales SA, Technip

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international comity may be particularly severe where a global class action under Section 10(b) might threaten the solvency of a foreign nation’s major corporation, thereby risking direct adverse impacts on that nation’s economic interests.73

d. United States Government’s View

The U.S. Solicitor General, joined by the Commission, submitted an amicus curiae brief on behalf of the United States that recommended a standard that would permit a private plaintiff who suffered a loss outside the United States as part of a transnational securities fraud to pursue redress under Section 10(b) if the U.S. component of the fraud directly caused the plaintiff’s injury.74 This direct-injury standard was more restrictive than that which the Solicitor General advocated for Commission and DOJ enforcement actions,75 but a broader standard than the domestic-transactions standard urged by the defendants. As the Solicitor General explained, the plaintiffs would have lost under the direct-injury standard.

In explaining the basis for this more restrictive standard for private actions than for public enforcement actions, the Solicitor General stated that “SEC enforcement actions are unlikely to produce conflict with foreign nations because the Commission routinely works with its overseas

SA, and Vivendi SA, at 6 (Feb. 26, 2010) (available at 2010 WL 719336) (hereinafter “Brief for Aeronautic Defense et al.”) (“Superimposing U.S. anti-fraud regulation – via U.S.-based class action litigation – on the[] carefully considered and sophisticated European regulatory regimes would effectively override important policy decisions that the EU and its member states have sought to implement.”). See also Brief for NYSE Euronext, at 12 (stating that “an imposition of U.S. law over foreign transactions is directly at odds with the years of effort that the U.S. has devoted to promoting cooperation with foreign governments in the regulation of securities trading”); Brief for SIFMA, et al., at 26 (“hamper efforts of international coordination for regulating global markets”); Brief for Aeronautic Defence, et al., at 24 (“At least fifteen foreign countries – including France, the Netherlands, Germany, Great Britain, Italy, and Belgium – have enacted blocking legislation in an effort to ensure that their sovereign policy choices regarding the conduct of civil litigation are not overridden by U.S. courts.”).

73 Brief for the Organization for International Investment, at 9 (Feb. 25, 2010) (available at 2010 WL 719335).

74 See Brief for the United States, at 27 (Feb. 26, 2010) (available at 2010 WL 719337).

75 The Solicitor General argued that the Commission and DOJ should be able to maintain an enforcement action under Section 10(b) if significant conduct material to the fraud’s success occurs in the United States. See Brief for the United States Government, at 16. This standard reflected the broad version of the conduct test that had been adopted by the Courts of Appeals for the Third, Eighth, and Ninth Circuits. See supra discussion at page 11 and cases cited in footnote 23. As discussed above, Congress has now codified a similarly broad standard for Commission and DOJ enforcement actions. See Dodd-Frank Act § 929P(b)(2).

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counterparts to develop coordinated approaches to enforcement.”76 By contrast, private securities actions “present a significant risk of conflict with foreign nations because the United States affords private plaintiffs litigation procedures and remedies that other countries often do not provide.”77 As examples, the Solicitor General stated that, “unlike many other countries, the United States permits securities class actions and use of the fraud-on-the-market theory to establish reliance in those actions.”78 The direct injury standard, by requiring private plaintiffs to establish that their losses were a direct result of conduct in the United States, would “mitigate[]that risk by limiting the availability of United States remedies to situations in which domestic conduct is closely linked to the plaintiff’s grievance.”79

The Solicitor General opposed the defendants’ transactional test, expressing concern that, under such an approach, “Section 10(b) would not apply to a fraud that was hatched andexecuted entirely in the United States and that injured domestic investors if the transactions induced by the fraud were executed abroad.”80 Yet, “Section 10(b) would apply to a fraud even if its only connection to the United States was that the injured foreign investor happened to be here when the fraudulent transaction was consummated.”81 Such “arbitrary” outcomes, the Solicitor General stated, would not comport with the Congressional purposes behind Section 10(b), which include ensuring honest securities markets, promoting investor confidence, and preventing the exportation of securities fraud to other nations.82

e. Views Expressed by Foreign Governments

The British, French, and Australian Governments filed briefs in the Morrison caseopposing to various degrees the cross-border extension of a private right of action under Section 10(b).83

76 Id. at 26.

Each emphasized that other nations’ approaches to securities regulation and litigation

77 Id. at 27.

78 Id.

79 Id. Further, the Solicitor General explained that a direct-injury requirement would alleviate the danger that the resources of U.S. courts would be diverted to redress securities-related harms suffered outside the United States having only an attenuated connection to this country. Id. at 28.

80 Id. at 21.

81 Id. at 22.

82 Id. at 21-22.

83 The Swiss Government submitted a diplomatic note that, although not proposing a specific standard, expressed the view that “[t]he United States should not purport to provide civil remedies for alleged securities law violations committed by non-U.S. corporations against non-

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differ in important respects from the U.S. approach,84 and “those differences represent legitimate policy choices and sovereign interests that ought to be respected by the United States.”85

• The British Government argued that the Section 10(b) private action should not be available to purchasers of securities on a foreign exchange who are injured by misleading statements or omissions made outside of the United States by the foreign issuer.86

U.S. persons on non-U.S. securities exchanges.” Swiss Embassy Note No. 17/2010, at 1-2(attached as Appendix A to Brief for International Bankers et al. (available at 2010 WL 723004)). The Swiss Government asserted that “international mutual assistance is the most effective mechanism for combating instances of genuinely transnational securities fraud schemes.” Id. at 3.

Such a bright-line standard

84 In addition to identifying a number of substantive and procedural differences between U.S. and foreign law with respect to private securities actions, the British Government identified a more fundamental disagreement “as to the desirability and appropriateness of even having a private right of action against an issuer for securities fraud.” Brief for the United Kingdom of Great Britain and Northern Ireland, at 18 (Feb. 25, 2010) (available at 2010 WL 723009) (hereinafter “Brief for U.K.”). “Unlike a claim against an individual wrongdoer that would be paid from personal assets, a claim against a public company by former shareholders, if successful, imposes the costs of compensation for losses on current shareholders.” Id. The British Government asserted that “the result can be a mere transfer of wealth from one group of innocent investors to another, with large transaction costs in the form of legal fees and expenses.” Id.

85 Brief for U.K., at 5-6. See also, e.g., Brief for the Republic of France, at 20, 22 (Feb. 26, 2010) (available at 2010 WL 723010) (hereinafter “Brief for France”) (stating the United States does not have a “valid interest” in applying its “chosen method of remedying securities fraud” –i.e., “privately initiated class actions instituted by plaintiffs’ attorneys working on a contingency-fee basis” – “to foreign securities transactions”); Brief for the Government of the Commonwealth of Australia, at 22-23 (Feb. 26, 2010) (available at 2010 WL 723006) (hereinafter “Brief for Australia”) (stating that “[a]dopting appropriate legal processes is a basic sovereign function on which reasonable sovereigns can differ” and requesting “respect [for] Australia’s sovereign judgments on civil procedures, especially when the litigation concerns Australian citizens suing an Australian corporation over conduct that occurred in Australia”); Swiss Embassy Note No. 17/2010, at 2 (asserting that permitting private rights of action under Section 10(b) for foreign citizens who trade securities of foreign issuers on foreign exchanges “would interfere with the sovereignty of foreign nations, which have the right to regulate securities-related activities within their own territory without interference from U.S. civil lawsuits”).

86 Brief for U.K., at 3 & n.7. The British Government did state that an “SEC enforcement action (unlike a private suit) permits the opportunity for cooperative dialogue with foreign regulators” and that “[s]uch dialogue and cooperation limit the risks of conflict with regulation by another state and of duplicative foreign litigation.” Id. at 38-39.

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“would allow issuers to plan their global affairs and assess their potential legal exposure with greater confidence and provide investors with a clearer understanding of where they can seek relief for alleged securities fraud.”87

• The French Government supported a bright-line standard under which the Section 10(b) private action would not extend to frauds involving foreign plaintiffs suing a foreign company for losses suffered in connection with the purchase or sale of securities on a foreign exchange.88

• The Australian Government suggested that the conduct test should be abandoned in favor of a standard that would require a tight factual nexus between the U.S. conduct and the alleged injury.89

3. The Supreme Court’s Decision in Morrison

The Supreme Court’s Morrision decision rejected the conduct and effects tests in favor of a transactional test.90 In rejecting the conduct and effects tests, the Court explained that the testslacked textual support in the Exchange Act and contravened the presumption that a statute only applies domestically unless there is a clear indication that Congress intended otherwise.91

The

87 Id. at 30. See also id. at 27 (“Inherent in [investors’] investment decisions – and in the global flow of capital – is a choice of varying [regulatory and legal] safeguards. The market will align incentives appropriately if issuers are held responsible by the jurisdiction in which they have issued their securities and if investors know they can seek redress for harms in the jurisdiction in which they purchased or traded securities.”).

88 Brief for France, at 18. The French Government expressed concern that allowing foreign investors to sue foreign companies for losses resulting from transactions on foreign exchanges would promote “international forum shopping” by “foreign plaintiffs who believe they can obtain a better result in the U.S.” Id. at 29-30. The French Government explained that this could, in turn, cause greater difficulties for foreign regulatory authorities and courts that are attempting to resolve such disputes because the injured investors will know that they have “the option of bypassing the [foreign] regulatory system altogether by filing a lawsuit in the U.S.” Id.at 30.

89 Brief for Australia, at 31-32.

90 See Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869, 2888 (2010).

91 Id. at 2878. For a historical discussion of the Supreme Court’s application of the presumption against extraterritoriality that includes the Morrison decision, see generally John H. Knox, The Unpredictable Presumption Against Extraterritoriality, 40 S.W. L. REV. 635, 636-49(2011).

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Court was critical of the ad-hoc balancing approaches that the conduct and effects testsemployed, stating that “[t]here is no more damning indictment of the ‘conduct’ and ‘effects’ test[s] than the Second Circuit’s own declaration that ‘the presence or absence of any single factor which was considered significant in other cases … is not necessarily dispositive in future cases.’”92

The Court instructed that, under the transactional test, “Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”93 In adopting the transactional test, the Court was mindful of the concerns of foreign governments and other foreign entities that urged adoption of a bright-line standard that would limit Section 10(b)’s interference with foreign securities regulation, stating that the transactional test “meets that requirement.”94 The Court explained that the “probability of incompatibility” with other nations’ securities laws is “obvious,”95 stating:

Like the United States, foreign countries regulate their domestic securities exchanges and securities transactions occurring within their territorial jurisdiction. And the regulation of other countries often differs from ours as to what constitutes fraud, what disclosures must be made, what damages are recoverable, what discovery is available in litigation, what individual actions may be joined in a single suit, what attorney’s fees are recoverable, and many other matters.96

Further, the Court seemed to believe that the risk that the United States might export securities frauds overseas to the detriment of foreign investors was outweighed by the potential threat of regulatory conflict and international discord that private securities class actions can pose in the context of transnational securities frauds. As the Court viewed it, “[w]hile there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on foreign securities markets, some fear that it has become the Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets.”97

92 Id. at 2879 (quoting IIT v. Cornfeld, 619 F.2d 909, 918 (2d Cir. 1980)).

93 Id. at 2888. See also id. at 2884 (“[I]t is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which §10(b) applies.”).

94 Id. at 2885.

95 Id. at 2886.

96 Id.

97 Id. To the extent that the Morrison decision can be understood to suggest that the perpetration of securities frauds from the United States on investors in other countries is not a significant problem, this view is not supported by the following recent Commission enforcement actions:

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Justice Stevens filed a concurrence, joined by Justice Ginsburg, in which he expressed support for the conduct and effects tests.98 He explained that the conduct and effects tests“strike[] a reasonable balance between the goals of preventing the export of fraud from America, protecting shareholders, enhancing investor confidence, and deterring corporate misconduct, on the one hand, and conserving United States resources and limiting conflict with foreign law, on the other.”99

• In the Matter of Aurelio Rodriquez, No. 3-14678, and In the Matter of Investment

Placement Group, et al., No. 3-14677 (S.E.C. Administrative Proceedings filed Dec. 23, 2011) (orders instituting Administrative Proceedings available at:

Justice Stevens also criticized the transactional test as unduly excluding from

http://www.sec.gov/litigation/admin/2011/33-9289.pdf and http://www.sec.gov/litigation/admin/2011/34-66055.pdf) (California-based brokerage firm acted in concert with a Mexican investment adviser to unnecessarily insert a separate broker-dealer as a middleman into securities transactions in order to generate millions of dollars of fraudulent additional fees, causing investors to pay approximately $65 million more than they would have without the middleman);

• SEC v. Seisma Oil Research, LLC, et al., No. 5:10-CV-95 (N.D. Texas filed June 16, 2010) (litigation release available at: http://www.sec.gov/litigation/litreleases/2010/lr21562.htm) (a Florida resident and three affiliated companies allegedly fraudulently sold investments in Texas oil and gas projects to more than 400 non-U.S. investors, raising at least $25 million);

• SEC v. Peter C. Son, et al., No. CV-09-2554 MMC (N.D. Cal. filed June 9, 2009) (litigation release available at: http://sec.gov/litigation/litreleases/2009/lr20881.htm) (two California residents and two companies they controlled allegedly conducted an $80 million Ponzi scheme that targeted approximately 500 investors in the United States, South Korea, and Taiwan); and

• SEC v. Stefan H. Benger, et al., No. 09-CV-00676 (N.D. Ill. filed Feb. 3, 2009) (litigation release available at: http://sec.gov/litigation/litreleases/2009/lr20881.htm) (massive and ongoing international boiler room scheme that allegedly sold shares of U.S. penny stock raising at least $44.2 million from 1,400 investors in Europe).

98 See id. at 2888-95 (Stevens, J., concurring in the judgment). Although generally supporting the conduct and effects tests, Justice Stevens did suggest that a bar on foreign-cubed actions would be appropriate. Id. at 2894-95 n.11 (“In recognition of the Exchange Act's focus on American investors and the novelty of foreign-cubed lawsuits, and in the interest of promoting clarity, it might have been appropriate to incorporate one bright line into the Second Circuit's test, by categorically excluding such lawsuits from §10(b)’s ambit.”).

99 Id. at 2893-94 (Stevens, J., concurring in the judgment) (footnote and internal citations omitted).

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private redress under Section 10(b)’s reach “frauds that transpire on American soil or harm American citizens.”100 He posed the following situation:

Imagine, for example, an American investor who buys shares in a company listed only on an overseas exchange. That company has a major American subsidiary with executives based in New York City; and it was in New York City that the executives masterminded and implemented a massive deception which artificially inflated the stock price – and which will, upon its disclosure, cause the price to plummet. Or, imagine that those same executives go knocking on doors in Manhattan and convince an unsophisticated retiree, on the basis of material misrepresentations, to invest her life savings in the company’s doomed securities. Both of these investors would, under the Court’s new test, be barred from seeking relief under §10(b).101

III. Application of the Transactional Test: Issues Addressed in Post-Morrison Decisions

Since the Morrison decision, the lower federal courts have addressed a number of questions regarding the interpretation and application of the transactional test. The discussion below highlights the eight principal issues that the federal courts have addressed through January 1, 2012.

For purposes of this discussion, prong 1 of the transactional test refers to a “purchase or sale of a security listed on an American stock exchange,” and prong 2 of the test refers to “the purchase or sale of any other security in the United States.”102 Subsections A through C discussissues involving the application of prong 1 of the transactional test; Subsection D addresses issues involving the application of prong 2 of the transactional test; and Subsections E through H address application of the test to transnational securities frauds involving a security-based swap, fraud by an intermediary, insider trading, and an off-shore feeder fund.

At the outset, it should be observed that there appears to be no dispute that foreign investors who purchase securities either through a U.S. exchange or otherwise in the United States fall within the transactional test.103

100 Id. at 2895 (Stevens, J., concurring in the judgment).

101 Id. (Stevens, J., concurring in the judgment).

102 Morrison, 130 S. Ct. at 2888.

103 See, e.g., Foley v. Transocean Ltd., 272 F.R.D. 126, 133-34 (S.D.N.Y. 2011) (stating Morrison provides no support for the “notion that foreign investors are not adequate plaintiffs in the United States courts when the securities at issue were purchased on a United States exchange”); Lapiner v. Camtek, Ltd., No. 08-01327, 2011 WL 445849, at *2 (N.D. Cal. Feb. 2, 2011); Hufnagle v. Rino Int’l Corp., No. 10-8695, 2011 WL 710704, at *8 (C.D. Cal. Feb. 14, 2011), adopted by 2011 WL 710676 *1 (C.D. Cal. Feb. 16, 2011). Cf. generally Hannah L. Buxbaum, Remedies for Foreign Investors Under U.S. Federal Securities Law, 75 LAW &

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A. Is the “Purchase or Sale of a Security Listed on an American Exchange” Prong of the Transactional Test Satisfied if a TransactionInvolves a Security that Is “Listed” on a U.S. Securities Exchange, or Must the Actual Transaction that Resulted in the Investor’s Loss Have Occurred on the U.S. Exchange?

District courts that have considered the issue have consistently held that, under prong 1 of the transactional test, the transactions at issue must occur on a domestic exchange to trigger application of Section 10(b)’s private right of action.104 Thus, an investor in a cross-listed security cannot maintain a Section 10(b) cause of action if he or she purchased or sold the security on the foreign exchange.105 As one court explained, “[t]hough isolated clauses of the [Morrison] opinion may be read as requiring only that a security be ‘listed’ on a domestic exchange for its purchase anywhere in the world to be cognizable under the federal securities laws, those excerpts read in total context compel the opposite result.”106 As another court explained, the “clear … concern [in Morrison] is on the true territorial location where the purchase and sale was executed and the particular securities exchange laws that governed the transaction.”107 “The idea that a foreign company is subject to U.S. securities laws everywhere it conducts foreign transactions merely because it has ‘listed’ some securities in the United States is simply contrary to the spirit of Morrison.”108

CONTEMP. PROBS. 101, 113-23 (2011) (discussing the potential for foreign investors to seek recovery in U.S. courts for claims arising under foreign securities law).

104 See, e.g., In re UBS Sec. Litig., No. 07-11225, 2011 WL 4059356, at *4-6 (S.D.N.Y. Sept. 13, 2011); In re Vivendi Universal, S.A. Sec. Litig. (“Vivendi”), 765 F. Supp. 2d 512, 531 (S.D.N.Y. 2011); In re Royal Bank of Scotland Group PLC Sec. Litig. (“Royal Bank of Scotland”), 765 F. Supp. 2d 327, 336 (S.D.N.Y. 2011); In re Alstom SA Sec. Litig. (“Alstom”), 741 F. Supp. 2d 469, 473 (S.D.N.Y. 2010); In re Celestica Inc. Sec. Litig., No. 07-312, 2010 WL 4159587, at *1 n.1 (S.D.N.Y. Oct. 14, 2010); Sgalambo v. McKenzie, 739 F. Supp. 2d 453, 487 & n.216 (S.D.N.Y. 2010).

105 It should be noted that, as it is being applied by the lower federal courts, the transactional test focuses on whether the private party bringing the Section 10(b) claim engaged in a domestic transaction, not whether the alleged wrongdoer did so. See SEC v. Compania Internacional Financiera S.A., No. 11-4904, 2011 WL 3251813, at *6 (S.D.N.Y. July 29, 2011) (explaining that Morrison “never states that a defendant must itself trade in securities listed on domestic exchanges or engage in other domestic transactions”).

106 Alstom, 741 F. Supp. 2d at 472.

107 Royal Bank of Scotland, 765 F. Supp. 2d at 336.

108 Id. One district court did acknowledge, however, that the alternative view does have supporting policy rationales. Vivendi, 765 F. Supp. 2d at 528-29. As this court explained, “[w]hen a foreign issuer decides to access U.S. capital markets by listing and trading ADRs [seediscussion in Appendix A, infra], it subjects itself to SEC reporting requirements, and it would

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B. Are Purchases and Sales of American Depositary Receipts Covered by Section 10(b)?

The courts that have considered the issue have concluded that a transaction involving ADRs109 on a domestic securities exchange falls within the scope of prong 1 of the transactional test.110

However, one district court has held that transactions in ADRs that trade in the United States on the over-the-counter-market (and thus not on an exchange) 111

not be illogical to subject that company to the antifraud provisions of the Exchange Act at least where there is a sufficient nexus to the United States.” Id. at 529. But see In re UBS Sec. Litig.,2011 WL 4059356, at *6 (rejecting a “listing theory” under which a defendant would be subject to Section 10(b) private actions “by cross-listing securities on multiple exchanges” and thus “consent[ing] to ‘regulation in the multiple jurisdictions in which the ordinary shares are registered,’” and explaining that “the issue here is not whether Defendants, by listing shares of stock on the NYSE, consented to regulation by the United States government …, but whether Congress intended a private right of action to apply extraterritorially such that it reaches transactions that are executed on foreign exchanges”).

do not qualify as domestic transactions under the transactional test, at least for purposes of a Section 10(b) private

109 “An ADR is a receipt that is issued by a depositary bank that represents a specified amount of a foreign security that has been deposited with a foreign branch or agent of the depositary, known as the custodian.” Pinker v. Roche Holdings Ltd., 292 F.3d 361, 367 (3d Cir. 2002). “The holder of an ADR is not the title owner of the underlying shares; the title owner of the underlying shares is either the depositary, the custodian, or their agent.” Id. ADRs trade “in the same manner as any other registered American security, may be listed on any of the major exchanges in the United States or traded over the counter, and are subject to the [federal securities laws].” Id. “This makes trading an ADR simpler and more secure for American investors than trading in the underlying security in the foreign market.” Id. See generally discussion of ADRs in Appendix A, infra.

110 See, e.g., Vivendi, 765 F. Supp. 2d at 527; Stackhouse v. Toyota Motor Co., No. 10-CV-0922, 2010 WL 3377409, at *1-2 (C.D. Cal. July 16, 2010); In re Elan Corp. Sec. Litig., No. 08-Civ.-8761, 2011 WL 1442328, at *1 (S.D.N.Y. Mar. 18, 2011).

111 All trades not executed on an exchange are considered “over-the-counter.” This includes not only bilateral transactions between parties, but also trades executed on alternative trading systems (“ATSs”) and other electronic trading platforms. ATSs typically are electronic trading systems that automatically match buy and sell orders of securities at specified prices using established, non-discretionary methods. ATSs carry out many of the same functions as exchanges, but, unlike exchanges, do not set rules governing the conduct of their subscribers(other than the conduct of such subscribers’ trading on the system) or discipline subscribers other than by exclusion from trading. See Regulation ATS, 17 C.F.R. §§ 242.300 and following.

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action against the issuer of the underlying foreign securities.112 Although the court’s analysis was somewhat ambiguous, it appears that the court reasoned that purchasing ADRs over-the-counter is a “predominantly foreign securities transaction” because the transaction occurs “in a less formal” market with lower exposure to U.S.-resident buyers than a formal securities exchange.113

112 In re Société Générale Sec. Litig. (“Société Générale”), No. 08-2495, 2010 WL 3910286, at *6-7 (S.D.N.Y. Sept. 29, 2010).

113 Id. at *6. One commentator has suggested that the Société Générale decision may be based on the fact that ADRs traded over-the-counter are frequently unsponsored, meaning that the issuer of the underlying foreign security was not responsible for the ADRs’ creation, while exchange-traded ADRs are always sponsored by the foreign issuer. See James Wilson, One Year Later: The Reach of U.S. Securities Laws After Morrison, LEXIS-NEXIS EMERGING ISSUES ANALYSIS, May 25, 2011, available at LEXIS, 2011 Emerging Issues 5668. See also Hannah L. Buxbaum, Remedies for Foreign Investors Under U.S. Federal Securities Law, 75 LAW &CONTEMP. PROBS. 107 (2011) (“The holding in Société Générale is difficult to square with the Morrison test …. If a foreign issuer has chosen to establish an ADR program in the United States, and is then charged with perpetrating a fraud in order to inflate the value of the U.S.-traded securities, it would be reasonable to apply U.S. antifraud law to resulting claims.” (footnote omitted)). See generally discussion of ADRs in Appendix A, infra.

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C. How Does the Transactional Test Apply to “Foreign-Squared” Cases – i.e., U.S. Investors Purchasing Foreign Securities on a Foreign Exchange?

Courts have thus far held that the purchase or sale of a security by a U.S. investor on a foreign exchange is not within the reach of Section 10(b.)114 These courts have consistently held that prong 1 of the transactional test makes clear that a transaction on a foreign exchange is not actionable in a Section 10(b) private action.115 Further, these courts have rejected arguments by U.S. investors that, because the transaction on the foreign exchange was initiated in the United States116 or involved a U.S. investor,117 prong 2 of the transactional test should apply.

In reaching this conclusion, courts have explained that it would amount to a “restoration” of the core elements of the conduct and effects tests to “exclude from operation of the [Morrison]test transactions in securities traded only on exchanges abroad if the purchase or sale involves American parties, or if some aspects or contacts of such foreign transactions occur in the United States.”118

114 See, e.g., Vivendi, 765 F. Supp. 2d at 531; Royal Bank of Scotland, 765 F. Supp. 2d at 337; Plumbers’ Union Local No. 12 Pension Fund v. Swiss Reinsurance Co. (“Plumber’s Union”), 753 F. Supp. 2d 166, 178-79 (S.D.N.Y. 2010); Société Générale, 2010 WL 3910286, at *5-6; Alstom, 741 F. Supp. 2d at 472-73; Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620, 625-26 (S.D.N.Y. 2010).

The courts addressing this issue have further explained that any exception that would

115 See, e.g., Stackhouse, 2010 WL 3377409, at *1.

116 Plumbers’ Union, 753 F. Supp. 2d at 179 (“For the purposes of determining whether a securities transaction is a ‘domestic’ transaction under Morrison, the country in which an investor happened to be located at the time that it placed its purchase order is immaterial”). See also In re UBS Sec. Litig., 2011 WL 4059356, at *7-8.

117 Plumbers’ Union, 753 F. Supp. 2d at 178 (“A purchaser’s citizenship or residency does not affect where a transaction occurs; a foreign resident can make a purchase within the United States, and a United States resident can make a purchase outside the United States.”); Vivendi,765 F. Supp. 2d at 533 (stating that “the American citizenship of a person who purchase[s] a foreign company’s shares on a foreign exchange does not render that a ‘domestic transaction’”).

118 Cornwell, 729 F. Supp. 2d at 624. See also Société Générale, 2010 WL 3910286, at *6 (“By asking the Court to look at the location of the act of placing a buy order …, Plaintiffs are asking the Court to apply the conduct test specifically rejected in Morrison.”) (internal quotation marks omitted); Royal Bank of Scotland, 765 F. Supp. 2d at 337 (“Plaintiffs’ approach – that it is enough to allege that Plaintiffs are U.S. residents who were in the country when they decided to buy [foreign exchange traded] shares – is exactly the type of analysis that Morrison seeks to prevent.”); Cascade Fund LLP v. Absolute Capital Management Holdings Ltd., No. 08-01381,2011 WL 1211511, at *5-7 (D. Colo. Mar. 31, 2001) (explaining that the transactional test applies irrespective of whether the investors were U.S. residents and to do otherwise would “simply [be] a restatement of the … discredited ‘effects test’”).

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allow private Section 10(b) actions for foreign exchange purchases directed from the United States would conflict with the transactional test’s goal of avoiding interference with foreign securities regulation given that foreign countries regulate their domestic securities exchanges and the transactions on those exchanges.119 As one court characterized it, “because the actual transaction takes place on the foreign exchange, the purchaser or seller has figuratively traveled to that foreign exchange – presumably via a foreign broker – to complete the transaction.”120

D. When Does a Purchase or Sale of Securities not Listed on a U.S. orForeign Exchange Take Place in the United States?

When a transaction constitutes a domestic transaction under prong 2 of the transactional test is perhaps one of the most difficult issues that the courts have been dealing with in the wake of Morrison. 121

This is so in significant part because the Supreme Court was silent as to when an off-exchange transaction occurs in the United States. All that can conclusively be said thus far is that the lower federal courts’ opinions suggest that the “bright-line” standard that the

119 Royal Bank of Scotland, 765 F. Supp. 2d at 337. See also Plumbers’ Union, 753 F. Supp. 2d at 178 (explaining that to allow U.S. residents to sue under Section 10(b) for purchases on foreign exchanges would “produce the regulatory multiplicity that the Supreme Court has directed courts to avoid”); Cornwell, 729 F. Supp. 2d at 624-25 (stating that “substantial concern” underlying the transactional test was that U.S. courts “would be called upon to enforce American laws regulating transactions in securities that are also governed by the laws of the foreign country and exchanges where those securities were actually purchased or sold”).

120 Stackhouse, 2010 WL 3377409, at *1.

121 See, e.g., Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc. (“Basis Yield”), 798 F. Supp. 2d 533, 537 (S.D.N.Y. 2011); United States v. Coffman, 771 F. Supp. 2d 735, 737-38 & n.1 (E.D. Ky. 2011). See generally Hannah L. Buxbaum, Remedies for Foreign Investors Under U.S. Federal Securities Law, 75 LAW & CONTEMP. PROBS. 101, 107-08 (2011) (“Determining the location of non-exchange-based transactions has proved quite complicated. Not surprisingly, many investment transactions involve touches with multiple countries or are executed by electronic or other means to which it is difficult to assign a location.”); id. at 113 (explaining that “in extending a bright-line test to all forms of investment transactions, the [Supreme Court in Morrison] ignored the substantial variability of such transactions”). A related question that one district court has addressed so far is how market manipulation of the U.S. over-the-counter market should be analyzed under the transactional test. See SEC v. Ficeto, No. CV 11-1637, 2011 U.S. Dist. LEXIS (C.D. Cal. Dec. 20, 2011) (“Market manipulation of domestic over-the-counter securities simply does not implicate the extraterritorial application of our securities laws. Accordingly, Morrison does not bar the application of § 10(b) to the facts presented in this case: foreign and domestic Defendants who allegedly engaged in manipulative trading tactics on the domestic over-the-counter securities market.”).

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Supreme Court hoped to set forth in Morrison has proven to be a fact-intensive question in the context of off-exchange transactions.122

Courts have set forth a number of potentially competing approaches for determining whether an off-exchange transaction occurs in the United States. One approach presupposes that securities transactions may take place across more than one jurisdiction. Therefore, courts must examine the entire transaction process to determine if any of the critical steps occurred domestically.123 When “an offer is made in one state and accepted in another,” the transaction is deemed to have taken place in both jurisdictions because both nations have an interest in regulating the transaction.124

Another approach that some courts have followed is to examine the transaction closely to determine precisely when in the course of the purchase or sale “the parties incurred ‘irrevocable liability’ to complete the transaction.”125 If the event resulting in irrevocable liability occurred in the United States, then a Section 10(b) private remedy would be available; if that event occurred elsewhere, a Section 10(b) private remedy would not be available.126

122 See, e.g., id. at 737-38; Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 2d 372, 405 (S.D.N.Y. 2010); SEC v. Goldman Sachs & Co. (“Goldman Sachs & Co.”), 790 F. Supp. 2d 147,157-63 (S.D.N.Y. 2011); Basis Yield, 789 F. Supp. 2d at 537 (stating “courts dealing with securities not traded on any exchange … have had to define when a purchase or sale occurs so that it can determine where the transaction took place”) (emphasis in original); Quail Cruises Ship Mgmt. v. Agencia de Viagens CVC Tur Limitada, 732 F. Supp. 2d 1345, 1349-50 (S.D. Fla. 2010), rev’d, 645 F.3d 1307 (11th Cir. 2011).

123 Cf. In re Nat’l Century Fin. Enters. (“Nat’l Century”), 755 F. Supp. 2d 857, 879-88 (S.D. Ohio 2010) (relying on Morrison’s transactional test to construe the extraterritorial reach of the Ohio Securities Act).

124 Nat’l Century, 755 F. Supp. 2d at 880 (citing A.S. Goldman & Co. v. N.J. Bureau of Securities, 163 F.3d 780, 787 (3d Cir. 1999)). But see Goldman Sachs & Co., 790 F. Supp. 2d at 158 (rejecting a standard that would look to “the entire selling process” to determine if the transaction occurred in the United States). But see generally In re Merkin, __ F. Supp. 2d __, __, No. 08-10922, 2011 WL 4435873 (S.D.N.Y. Sept. 23 2011) (rejecting argument that U.S. residents’ purchase or sale of off-exchange securities does not, standing alone, create a presumption that the transactions occurred in the United States for purposes of the transactional test).

125 See, e.g., Basis Yield, 798 F. Supp. 2d at 537 (citing Goldman Sachs, 2011 WL 2305988, at *8).

126 See, e.g., Basis Yield, 798 F. Supp. 2d at 537; Anwar, 728 F. Supp. 2d at 405. One court has held that an investor’s transfer of the payment money for the purchase of securities to a U.S. bank is not sufficient to satisfy the transactional test where the payment of the funds was “one step” in a sales process in which the seller, by the terms of the parties’ subscription agreement, still retained the right to accept or reject the transaction. See Cascade Fund, 2011 WL 1211511,

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Still other courts have suggested that either the issuance of the securities in the United States127 or “transfer of title to the shares in the United States”128 may satisfy the transactional test for purposes of a private action under Section 10(b).129 The Court of Appeals for the Second Circuit has endorsed both the “irrevocable liability” standard and the “transfer of title” standard,holding 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.”130

E. How Does the Transactional Test Apply When the Fraudulent Conduct Is not Engaged in by the Issuer of the Security, but Rather by Intermediaries such as Investment Advisers, Broker-Dealers, or Underwriters?

Although Morrison itself involved allegations of fraud by the foreign issuer, district courts have also applied the transactional test to cases involving fraud by intermediaries such as investment advisers, broker-dealers, and underwriters. In doing so, these courts have determined that Section 10(b) does not apply if the transaction for which the investor suffered a loss occurred either on a foreign exchange or otherwise outside the United States, even if (1) the intermediary resided in the United States and primarily engaged in the fraudulent conduct

at *7. One scholar has warned that the location-of-irrevocable-liability standard is subject to manipulation by a contracting party and “can be non-transparent to the other party” because “the seller of securities can simply situate itself outside the United States when formally engaging in an act of acceptance, and thereby avoid the application of U.S. law.” Hannah L. Buxbaum, Remedies for Foreign Investors Under U.S. Federal Securities Law, 75 LAW & CONTEMP.PROBS. 101, 113 (2011).

127 See In re Optimal U.S. Litig., 813 F. Supp. 2d 351, 73 (S.D.N.Y. 2011).

128 Quail Cruises Ship Mgmt. Ltd. v. Agencia de Viagens CVC Tur Limitada, 645 F.3d at 1310-11.

129 See generally United States v. Mandell, No. 09-Cr-0662, 2011 WL 924891, at *4 (S.D.N.Y. March 16, 2011) (stating that Section 10(b) private actions reach a fraudulent scheme involving the private placement of equity in the United States of securities traded on a foreign exchange).

130 Absolute Activist Value Master Fund Ltd. v. Ficeto, __ F.3d __, __, 2012 WL 661771, at *6 (2d Cir. March 1, 2012) (hereinafter “Ficeto”). See also id. at *8 (“Absent factual allegations suggesting that the [plaintiffs] became irrevocably bound within the United States or that title was transferred within the United States, including, but not limited to, facts concerning the formation of the contracts, the placement of purchase orders, the passing of title, or the exchange of money, the mere assertion that transactions ‘took place in the United States’ is insufficient to adequately plead the existence of domestic transactions.”).

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here,131 or (2) the intermediary traveled to the United States frequently to meet with the U.S. investor-client.132

While such cases may well have survived under the conducts and effects tests, the dispositive consideration now, according to the courts that have addressed the issue, is whether the transaction causing the investor’s loss occurred on a domestic exchange or was otherwise a purchase or sale in the United States.

F. How Does the Transactional Test Apply to a Security-Based Swap Transaction that References a Security Traded on a Foreign Exchange?

Section 10(b) of the Exchange Act also covers fraud in connection with the purchase orsale of a security-based swap.133 Securities fraud in connection with a security-based swap transaction could take a number of forms – for example, the fraudster could be a counterparty to the swap or a third party unrelated to the swap transaction such as the issuer of the referenced security; and the fraudulent statements or omissions could directly concern the referencedsecurity or relate exclusively to the security-based swap agreement.

Thus far, only one court has applied the transactional test to securities fraud involving a security-based swap. The court held that, at least to the extent that a counterparty to the swap is suing a third-party unrelated to the swap transaction for fraudulent conduct in connection withthe referenced security, the transactional test does not afford a cause of action under Section 10(b) for transactions in security-based swaps that reference a security traded on a foreign exchange.134

131 See Absolute Activist Value Master Fund Ltd. v. Homm, No. 09-CV-8862, 2010 WL 5415885, at *5 (S.D.N.Y. Dec. 22, 2010), rev’d sub nom Ficeto, __ F.3d __, 2012 WL 661771.

In reaching this holding, the court examined the “economic reality” of the swap transactions and concluded that the swap transactions were the “functional equivalent” of engaging in a short sale of the reference security on the foreign exchange because the gains and losses of the swap agreements were directly tied to the fluctuations in the foreign shares’ trading

132 Horvath v. Banco Comercial Portugues, S.A., No. 10-Civ.-4697, 2011 WL 666410, at *2-3 (S.D.N.Y. Feb. 15, 2011), aff’d 2012 WL 497276 (2d Cir. Feb. 16, 2012).

133 Security-based swaps are defined in Section 3(a)(68) of the Exchange Act, 15 U.S.C. § 78c(a)(68), and generally include swaps on single securities and narrow-based security indexes. Security-based swaps are in the definition of security under Section 3(a)(10) of the Exchange Act, 15 U.S.C. § 78c(a)(10). Section 10(b) of the Exchange Act also covers fraud in connection with the purchase and sale of security-based swap agreements, which are defined in Section 3(a)(78) of the Exchange Act, 15 U.S.C. § 78c(a)(78), and include securities-related swaps that are not security-based swaps (e.g., swaps on broad-based security indexes).

134 Elliott Assocs. v. Porsche Automobil Holding SE, 759 F. Supp. 2d 469, 473-76 (S.D.N.Y. 2010).

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price.135 The court thus concluded that these swap transactions should be deemed to have taken place on the foreign exchange under the transactional test irrespective of whether transactions in the security-based swaps themselves were entered into in the United States.136

The district court appeared particularly concerned that application of Section 10(b) to transactions in security-based swaps that reference a foreign security could create conflicts with foreign governments’ efforts to regulate their securities exchanges: “In light of Morrison’s strong pronouncement that U.S. courts ought not interfere with foreign securities regulation without a clear Congressional mandate, I am loathe to create a rule that would make foreign issuers with little relationship to the U.S. subject to suits here simply because a private party in this country entered into a derivatives contract that references the foreign issuer’s stock.”137

135 Id. at 476. In Valentini v. Citigroup, Inc., the district court relied on the “economic reality” standard to hold that “a transaction in securities that may, under certain circumstances, convert into domestically-traded stock qualif[ies] as a ‘transaction involving securities based on a domestic exchange’’ under prong 1 of the transactional test. No. 11-Civ.-1355, 2011 WL 6780915, at *13-14 (S.D.N.Y. Dec. 27, 2011). The securities at issue were equity linked notes, which the court explained “are complex debt instruments that differ from standard securities in that their value upon maturity is tied to the value of a third-party equity, such as stock, a basket of stocks or an equity index.” Id. at *1. All of the equity linked notes were linked to the value of ADRs or the common stock traded on U.S. securities exchanges. Id. Applying the “economic reality” standard in light of the facts that “the value of the notes rose and fell as the price of the [U.S.-exchange-traded] shares to which they were linked rose and fell” and “some of the notes were also convertible into those securities,” the court concluded that when the purchases acquired “these convertible notes, they were in effect purchasing a put option on those [U.S.-exchange-traded] stocks.” Id. at *14. Then relying on precedent that “held the purchase of an option … is equivalent, for purposes of §10(b) liability, with a purchase of that security,” id.(citing Caiola v. Citibank, N.A., 295 F.3d 312, 327 (2d Cir. 2002)), the district court held that “[u]nder the ‘economic reality’ approach,” the equity linked notes transactions that “involved convertible securities” “constitute ‘transactions involving securities on domestic exchanges’ and thereby satisfy Morrison’s [first] prong.” Valentini, 2011 WL 6780915, at 14.

136 Id. See also id. (“Although Morrison permits a cause of action by a plaintiff who has concluded a ‘domestic transaction in other securities,’ this appears to mean ‘purchases and sales of securities explicitly solicited by the issuer in the U.S.,’ rather than transactions in foreign-traded securities – or swap agreements that reference them – where only the purchaser is located in the United States.”) (citing Stackhouse, 2010 WL 3377409, at *1).

137 Elliott Assocs, 759 F. Supp. 2d at 476. See generally Wulf A. Kaal & Richard W. Painter, The Aftermath of Morrison v. National Australia Bank and Elliott Associates v. Porsche,8 EUR. COMPANY & FIN. L. REV. 77, 91 (2011) (recommending that a focus “on the totality of the circumstances could help establish appropriate parameters to determine where a privately negotiated derivative transaction takes place”).

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G. How Does the Transactional Test Apply When an Individual Engages in Insider Trading with Respect to a U.S. Listed Company by Purchasing Derivatives Overseas that Reference the U.S. Security?

One district court has held that Section 10(b) applies where a defendant engages in insider trading overseas with respect to a U.S. listed company by acquiring contracts for difference (“CFD”)138 that reference the company’s U.S. exchange-listed security.139 The court determined that the defendants’ purchase of the overseas CFDs fell squarely within the language of Section 10(b) because it was a manipulative or deceptive device or contrivance “in connection with” the U.S. exchange-traded stock. Further, the court rejected the defendants’ argument that the Morrison transactional test foreclosed the suit because the defendants’ purchase of the CFDs occurred overseas. The court explained that Morrison does not state “that a defendant must itself trade in securities listed on domestic exchanges or engage in other domestic transactions” for Section 10(b) to apply.140

H. How Is the Purchase of Shares in an Off-Shore Feeder Fund that Itself Invests in a U.S. Fund Treated Under the Transactional Test?

Investors who purchase shares of an off-shore feeder fund that holds itself out as investing exclusively or predominantly in a U.S. fund may have to demonstrate that their purchases of the off-shore fund’s shares occurred in the United States in order to maintain a

138 A contract for difference constitutes a security as defined by the federal securities laws. “CFD purchasers acquire the future price movement of the underlying company’s common stock (positive or negative) without taking formal ownership of the underlying shares.” SEC v. Compania Internacional Financier, No. 11-4904, 2011 WL 3251813, at *3 (S.D.N.Y. July 29, 2011) (quoting Freudenberg v. E*Trade Financial Corp., No. 07-Civ.-0538, 2008 WL 2876373, at *7 (S.D.N.Y. July 16, 2008)). The prices for CFDs are identical to the prices quoted for shares of the company’s stock, and in advance of pricing a CFD, the broker purchases matching shares of the stock on the U.S. exchange. See id. (“Because identical matched transactions occur in shares of the actual common stock immediately before the purchase or sale of the CFDs, any influence on the public market price of the underlying securities is also reflected in the price of the CFDs.”) (quoting Freudenberg, 2008 WL 2876373, at *7). One purported advantage of CFDs is that they allow foreign investors to access U.S. exchange-listed securities without the need to open a U.S. brokerage account. See id.

139 SEC v. Compania Internacional Financiera, No. 11-4904, 2011 WL 3251813 (S.D.N.Y. July 29, 2011).

140 Id. at 6-7 (stating that this “interpretation of Morrison would create a dramatically narrower view of § 10(b) liability, not only limiting its extraterritorial application, but also precluding actions against persons who themselves did not trade in securities”).

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Section 10(b) action for losses experienced as a result of the purchases.141 Although only one court has expressly addressed the issue, that court was unwilling to give foreign investors in these situations the benefit of a “pass through effect” under the Morrison test that might otherwise allow the investors to treat their purchases of the off-shore fund’s shares as the functional equivalent of purchasing shares in the United States.142 It explained that such an approach would effectively involve “examining a foreign investors’ intent to own United States securities,” which is an “unpredictable and subjective criterion” that would “eliminate thedoctrinal clarity that the Supreme Court provided in Morrison.”143

IV. Response to Request for Public Comment

A. Overview

The Commission received 72 comment letters (excluding duplicate and follow-upletters).144 Of these letters, 30 were from institutional investors or organizations representing them; 19 were from law firms and accounting firms; 8 were from foreign governments; 7 were from public companies or associations representing them; 7 were from academics; and 1 letter was from an individual investor. Further, 44 of the comment letters supported enactment of the conduct and effects tests or some modified version of the tests; 23 supported keeping the Morrison transactional test; and the remaining 4 either supported alternative approaches or simply provided additional information.

The comment letters submitted by investors and organizations representing investors uniformly supported enactment of the conduct and effects tests, or some modified versionthereof. By contrast, comment letters submitted by issuers and organizations affiliated with

141 Cf. Optimal, 813 F. Supp. 2d at 371-73; Anwar, 728 F. Supp. 2d at __; In re Banco Santander Securities-Optimal Litig. (“Banco Santander”), 732 F. Supp. 2d 1305, 1316-18 (S.D. Fla. 2010).

142 Banco Santander, 732 F. Supp. 2d at 1317-18.

143 Id. at 1317-18.

144 Copies of comment letters that the Commission received are available on the Commission’s website at http://www.sec.gov/comments/4-617/4-617.shtml. The comment letter submitted by Pomerantz, Haudek, Grossman and Gross, LLP (“Pomerantz”) included nine separate comment letters from pension funds. Each attached letter was considered as a separate comment letter for purposes of this section. Additionally, the letters submitted by Devon County Council Pension Fund, Lancashire County Pension Fund, Hampshire Pension Fund, and Cumbria Local Government Pension Scheme all incorporated and supported the letter submitted by Strathclyde Pension fund (“Strathclyde”). For purposes of this section, references to Strathclyde should be viewed as also representing the views of Devon County Council Pension Fund, Lancashire County Pension Fund, Hampshire Pension Fund, and Cumbria Local Government Pension Scheme.

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issuers uniformly supported the transactional test. With one exception, the comment letters from foreign national governmental authorities also favored the transactional test.145 The Israeli Securities Authority was the one exception, expressing the view that investors should be permitted to pursue a Section 10(b) private action against any issuer that has cross-listed its shares in the United States and Israel irrespective of whether they purchased the securities on a U.S. or Israeli exchange.146 The viewpoints expressed by academics and law firms varied –some supporting adoption of the conduct and effects tests, and others supporting retention of the transactional test.

Finally, only a few comment letters addressed whether the conduct and effects testsshould be extended just to institutional investors; these letters uniformly opposed any differenttreatment between institutional and non-institutional investors (e.g., retail investors). That said, comment letters did voice differing opinions on whether foreign investors should be treated differently than U.S. investors if some form of the conduct and effects tests are extended to private rights of action.

B. Comments Concerning the Morrison Transactional Test

1. Arguments in Favor of the Transactional Test

The comment letters that favored retaining the transactional test in large measure restated the arguments that the Morrison defendants and their amici advanced at the Supreme Court, and which are discussed above in Sections II.C.2.c and II.C.2.e.147

One argument asserted by a range of commenters – including foreign governmental authorities, issuers, law firms, and accounting firms – is that the extension of the conduct and effects tests to Section 10(b) private actions would create significant conflicts with other nations’ 145 The foreign national governmental authorities that supported the Morrison transactional test included: HM Treasury, U.K. Government (“U.K. Government”); Government of the Federal Republic of Germany; Government of France; Australian Government; European Commission; Government of Switzerland; and Autorité des Marchés Financiers (the French securities regulator). The Israel Securities Authority outlined situations where the transactional standard should not apply.

146 See letter from ISA, at 1. Under Israeli law, “an issuer that has listed its securities on certain U.S. exchanges and is therefore subject to SEC disclosure requirements may carry out a secondary listing on [the Tel Aviv Stock Exchange].” Id. at 2. Given that Israeli law hasexpressly “recognized the adequacy of U.S. disclosure for its own domestic regulatory requirements,” the Israeli Securities Authority expressed the view that the “right to bring a private action before the U.S. courts does not undermine international comity.” Id. at 3. 147 Of the 22 comment letters submitted in support of retaining the transactional test, 7 were from foreign government authorities; 7 were from issuers or professional associations representing issuers; 5 were from law firms or professional lawyers’ associations; 2 were from academics; and 1 was from a group of accounting firms.

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laws, interfering with the important and legitimate policy choices that these nations have made.148 For example, the European Commission’s comment letter, which “strongly urge[d] … against” a cross-border extension of Section 10(b), stated that an “extraterritorial application of the antifraud provisions of the United States’ securities laws … where the nexus is stronger with a foreign jurisdiction[] is liable to violate the E.U.’s and its Member States’ sovereignty, and to impede the proper development of [the] E.U.’s securities regulation.”149

Some comment letters supporting the transactional test also argued that the extension of the conduct and effects tests to private actions would result in what they believe to be costly and abusive litigation involving transactions that occur on foreign securities exchanges.150 One comment letter, for example, highlighted several procedural aspects of U.S. securities class actions that the letter asserts result in significant costs, also citing to a recent statement from the European Commission characterizing U.S. class actions as “creating incentives for abusive litigation.”151 Similarly, the U.K. Government comment letter highlighted, among other things, the “irrecoverable” high costs a U.K. company must incur when litigating in U.S. courts.152

Some of these comment letters argued that, by contrast, retention of the transactional test would foster market growth because the test provides a bright-line standard for issuers to

148 See, e.g., letters from U.K. Government; Government of the Federal Republic of Germany; Government of France; Australian Government; European Commission; Governmentof Switzerland; Autorité des Marchés Financiers (France); Law Society of England & Wales and the City of London Law Society; Vivendi; U.S. Chamber of Commerce; BDO International Limited; Deloitte Touche Tohmatsu Limited, Ernst & Young Global Limited, Grant Thornton International Ltd, KPMG International, PricewaterhouseCoopers International Limited, RSM International Limited (“BDO, et al.”). 149 Letter from European Commission, at 1. A number of comment letters supported this point by noting that other jurisdictions provide investor protection that is comparable to the level of investor protection provided by the U.S. securities laws. See, e.g., letters from Government of France; Australian Government; Government of Switzerland; Canadian Bar Association. 150 See, e.g., letters from U.S. Chamber of Commerce; U.K. Government; Government of France; Australian Government; Government of Switzerland; Autorité des Marchés Financiers (France); City of London Law Society; Vivendi. See also, e.g., Government of the Federal Republic of Germany; Embassy of Switzerland; Mouvement des Entreprises de France; the Federation of German Industries, Economiesuisse; the European Banking Federation; the Swiss Bankers Association, and the Institute of International Bankers (“Medef”); Deutsches Aktieninstitut; Securities Industry and Financial Markets Association and the Association for Financial Markets in Europe (“SIFMA”).

151 Letter from U.S. Chamber of Commerce, at 15. See also letters from Australian Government; Medef; City of London Law Society; White & Case.

152 See letter from U.K. Government, at 5.

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reasonably predict their liability exposure in Section 10(b) private actions.153 These commentletters also asserted that the transactional test appropriately respects international comity and sovereign interests. The European Commission, for example, stated that “in relation to private rights of action, we believe that the ‘transactional’ test … is in accordance with the principles of comity and international law, and helps to avoid unreasonable interference with sovereign authority of other nations.”154

2. Arguments Against the Transactional Test

As discussed below, comment letters raised a series of concerns with the transactional test.

a. Whether an Exchange-Traded Securities Transaction Occurs in the United States or Overseas May Not Be Apparent to Investors.

A joint comment letter submitted by sixty-nine foreign pension funds argued that “the Morrison test fails to recognize the realities of today’s modern trading environment, and is punitive to investors who often do not know whether their respective securities transaction was ultimately executed on a U.S. or foreign exchange.”155

153 See, e.g., letters from Skadden, Arps, Slate, Meagher & Flom, LLP (“Skadden”); U.S. Chamber of Commerce; White and Case; Vivendi; GC100 Group, the Association of General Counsel and Company Secretaries of the U.K. FTSE 100 (“GC100”); SIFMA; White and Case; EuropeanIssuers; Canadian Bar Association.

As a result, application of the

154 Letter from European Commission, at 3. See also letters from Government of the Federal Republic of Germany; U.K. Government; Government of Switzerland. 155 Letter from AGEST Superannuation Fund; Alecta Pensionsförsäkring, Ömsesidigt; AMF Fonder AB; AMF Pensionsförsäkring AB; APG Algemene Pensioen Groep N.V.; ASSETSuper Superannuation Fund; ATP - Arbejdsmarkedets Tillægspension; AUST (Q) Superannuation Fund; Australian Catholic Superannuation & Retirement Fund; Australian Institute of Superannuation Trustees; Australian Reward Investment Alliance; Australian Superannuation Fund; Australia’s Unclaimed Super Fund; AustSafe Superannuation Fund; AVSuper Superannuation Fund; Catholic Superannuation Fund; Construction & Building Industry Superannuation Fund; Danica Pension; Danske Invest Management A/S; Electricity Supply Industry Superannuation Fund; Emergency Services & State Superannuation Fund; Energy Industries Superannuation Scheme; FIL Investments International; FirstSuper Superannuation Fund; Folksam; Forsta AP-Founden; GMB Trade Union; Health Employees Superannuation Trust Australia; Health Superannuation Fund; HOSTPLUS Superannuation Fund; Industriens Pension; KLP Kapitalforvaltning; Labour Union Co-operative Retirement Fund; Legalsuper Superannuation Fund; Local Government Superannuation Scheme; Local Super (SA-NT) Superannuation Fund; Maritime Superannuation Fund; Media Superannuation Fund; Merseyside Pension Fund; Motor Trades Association of Australia Superannuation Fund; Non-Government Schools Superannuation Fund; Nordea Fondbolag Finland AB; Nordea Fondene Norge AS; Nordea Fonder AB; Nordea Investment Funds Company I S.A.; OMERS Administration

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transactional test may deny U.S. investors a private right of action under Section 10(b) without the investors having made any decision to forego such a remedy or even having an awareness that a loss of remedy has occurred.

According to some comment letters, the uncertainty about where a transaction occurs may result because broker-dealers under certain circumstances may be obligated to execute a trade on a non-U.S. exchange, even if the particular security is listed on a U.S. exchange.156 As one comment letter explained, “the United States ha[s] adopted legislation requiring brokers to establish a best execution policy to ensure that orders for securities are executed to the best benefit of the client.[157

Corporation; PFA Pension; PGGM Vermogensbeheer B.V. (PGGM Investments); Raiffiesien Capital Management; Retail Employees Superannuation Trust; Royal Mail Pension Plan; Sampension KP Livsforsikring A/S; SKAGEN A/S; Skandinaviska Enskilda Banken AB; SPEC Superannuation Fund; State Superannuation Scheme // SAS Trustee Corporation; Statewide Superannuation Fund; Sunsuper Superannuation Fund; Swedbank Robur Fonder AB; Syntrus Achmea; Tasplan Superannuation Fund; Telstra Superannuation Fund; The Australian Council of Superannuation Investors; TWUSUPER Superannuation Fund; UniSuper Superannuation Fund; Universities Superannuation Scheme; Varma Mutual Pension Insurance Company; VicSuper Superannuation Fund; VisionSuper Superannuation Fund

] In order to achieve ‘best execution,’ in the case of a [cross]-listed

(“AGEST et al.”). See also letters from Strathclyde; California Public Employees’ Retirement System (“CalPERS”); Scott + Scott, LLP (“Scott + Scott”); Forty-two Law Professors.

156 See, e.g., letters from AGEST, et al.; CalPERS; National Association of Shareholder and Consumer Attorneys (“NASCAT”); Leandro Perucchi; California State Teachers’ Retirement System (CalSTRS), Colorado Public Employees’ Retirement System, Delaware Public Employees’ Retirement System, State Board of Administration of Florida, North Carolina Department of State Treasurer, Connecticut Treasurer’s Office, Maryland State Retirement andPension System, Pennsylvania Public School Employees’ Retirement System, Rhode Island General Treasurer, Pennsylvania State Employees’ Retirement System, New York City Employees’ Retirement System, New York City Police Pension Fund, Teachers’ Retirement System of the City of New York, New York Fire Department Pension Fund, Board of Education Retirement System of the City of New York, Pension Reserves Investment Management Board Commonwealth of Massachusetts (“CalSTRS, et al.”).

157 U.S. brokers have a legal responsibility to seek to obtain the “best execution” reasonably available for their customers’ orders. See, e.g., Newton v. Merrill, Lynch, Pierce, Fenner & Smith, 135 F.3d 266, 269-70, 274 (3d Cir. 1998) (finding Merrill Lynch may have failed to maximize the economic benefit to its customers by failing to take advantage of prices better than the NBBO); In re Herzog, Heine, Geduld, LLC, Exchange Act Release No. 54148 (July 14, 2006) 2006 WL 1982741, at *5; In re Certain Market Making Activities on Nasdaq, Exchange Act Release No. 40900 (Jan. 11, 1999), 1998 WL 919673, at *5. Best execution means that the broker must seek to obtain for its customers the most favorable terms reasonably available under the circumstances, taking into account price, order size, trading characteristics of the security, speed of execution, clearing costs, and the cost and difficulty of executing an order in a particular market, as well as the potential for price improvement. See Newton, 135 F.3d at 270, n.2.

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security, the broker will execute the transaction on the exchange that provides the greatest [financial] advantage to the client, which could be a U.S. or a foreign exchange, depending on circumstances.”158 Under the transactional test, achieving best execution could result in transactions that fall outside the protection of the U.S. securities laws, even if the transactions are carried out by U.S. brokers on behalf of U.S. clients.

Another comment letter provided an additional potential explanation for why investors may not know the location of the transaction, explaining that at least one major U.S. securities broker-dealer has a policy that “‘if the securities are listed on more than one financial instruments exchange … we will place the order on the exchange which is selected … as the primary exchange[159] at the time of the execution.’”160 Thus, according to the comment letter, “[i]f purchasers of shares only have a [Section 10(b) private] cause of action if the trade occurs on a U.S. exchange, the purchaser has no idea at the time of purchase whether U.S. law will protect them, and investor protection becomes a random event.”161

Comment letters also asserted that the potential merger of domestic securities exchanges with foreign exchanges may complicate the question of where a transaction occurs. 162 As one comment letter explained,

[I]t is not going to be entirely clear very much longer to American investors if they are transacting on a foreign or domestic exchanges. When one purchases on the new Börse-NYSE or the NYSE-Börse … where will that transaction take place?[163] Where the buyer is located? Where the seller is located? In the country where the exchange itself determines to plant its network servers? In the country where the exchange is headquartered?”164

158 Letter from AGEST, et al., at 9.

159 The term “primary exchange” has often been used to refer to the market on which a security experiences the greatest trading volume. 160 Letter from CalSTRS, et al., at 11.

161 Id.

162 See, e.g., letters from NASCAT; Leandro Perucchi; Forty-Two Law Professors.

163 The proposed merger between NYSE Euronext (United States) and Deutsche Börse(German) that the commenter refers to has subsequently been terminated. 164 Letter from Scott + Scott, at 2 (emphasis in original). See also letter from Forty-Two Law Professors.

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Finally, several comment letters expressed concern that, following the Morrison decision, it may be unclear whether purchasing ADRs in the United States constitutes a domestic transaction under the transactional test.165

b. Transactional Test Impairs the Ability of U.S. Investment Funds to Achieve a Diversified Investment Portfolio.

Comment letters also discussed ways in which the transactional test complicates the efforts of many investment advisers to achieve a diversified portfolio for their clients.166 To achieve a fully diversified portfolio, investment advisers generally seek to include foreign securities holdings in their clients’ portfolios. Commenters asserted that acquiring ADRs on U.S. exchanges often may not be a viable option to achieve this diversification, and instead advisers must acquire the desired foreign securities directly through transactions on a foreign exchange:

Public pension funds such as CalPERS diversify their assets in order to protect their beneficiaries.… Given the enormous size of this investment and the limited number of foreign issuers whose securities trade in the U.S. in the form of ADRs, most of CalPERS international equity investments cannot be purchased as ADRs….167

Even when ADRs are available for particular foreign securities, comment letters identified several reasons why these are not an adequate means to achieve diversification. First,because ADRs are often less liquid than the underlying foreign securities, it may be impractical for large funds to purchase or sell the desired volume of ADRs within a time frame that is consistent with the funds’ needs or investment objectives.168

Second, U.S. institutional investors may be disadvantaged in achieving the best price because they are unable to immediately trade when material information is disclosed about the

165 See, e.g., letter from Hannah L. Buxbaum, at 3 (“But surely the United States’ regulatory interest in protecting its markets is triggered by fraud relating to any securities trading in those markets; and surely an investor who purchases [ADRs] on a U.S. securities exchange, or in the over-the-counter market in the United States, is entitled to the protection of U.S. antifraud law just as it would be had it purchased different securities in those markets.”). See also discussion at Section III.B, supra.

166 See, e.g., letter from CalPERS. Under the conduct and effects tests, investment advisers did not have to worry that the singular act of acquiring foreign securities on a foreign exchange could foreclose a Section 10(b) private remedy for their clients.

167 Letter from CalPERS, at 4.

168 See, e.g., letters from CalPERS and G.A. Karolyi.

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foreign security in the local market, forcing U.S. institutional investors instead to wait until the U.S. markets open to trade in the security’s ADRs. This gives rise to a dilemma that one commenter described as follows:

Why should American investors – including American pension funds – be relegated to waiting five or six hours for NY-based exchanges to open to transact in the securities of companies like BP and Shell – when the stock is trading on then current information throughout the trading day in different time zones in London and across Europe and Asia. Simply stated, the U.S. markets open later in the trading day and thus American investors are being put to the Hobson’s choice of transacting on foreign exchanges without the protections of the antifraud provisions of the U.S. securities laws, or waiting to trade until the U.S. markets open, potentially under adverse financial conditions where information disclosed during the overseas trading day has already been impacted into the price.169

Third, comment letters argued that trading in ADRs instead of the underlying foreignsecurity could impose significant additional costs on institutional investors such as pension funds and mutual funds.170 Indeed, one comment letter from an investment fund identified specific additional costs that would result if, in an attempt to achieve diversification while still attaining the protections of the U.S. securities laws, it were to acquire ADRs rather than the underlying foreign securities:

ADR issuers announce and disclose, in their 20-F filings[171

169 Letter from Scott + Scott, at 2.

] with the Commission, what charges are incident to a purchase of the ADRs. Among those

170 See, e.g., letters from CalPERS; Scott + Scott; Consolidated Retirement Fund. Providing empirical support for this position, G.A. Karolyi, an economist, noted a finding in one of his articles where he examined “a sample of 506 United States cross-listed stocks from 35 different companies and examine[d] arbitrage opportunities by the comparison of intraday pricing, between ADR markets and the ‘local’ market on a currency adjusted basis.” According to Karolyi, “the price of a single ADR, with all other factors controlled for, effectively cost 32 basis points more than the equity equivalent on the ‘local’ market.”

171 A foreign private issuer of securities is required to file with the Commission Form 20-F, 17 C.F.R. § 249.220f. Form 20-F is the combined registration statement and annual report form for foreign private issuers under the Exchange Act. It also sets forth disclosure requirements for registration statements filed by foreign private issuers under the Securities Act of 1933.

A foreign private issuer is a non-government foreign issuer, except for a company that (1) has more than 50% of its outstanding voting securities owned by U.S. residents, and (2) has either a majority of its officers and directors residing in or being citizens of the United States, a majority of its assets located in the United States, or its business principally administered in the United States. See Exchange Act Rule 3b-4(c), 17 C.F.R. § 240.3b-4(c).

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costs are the cost charged by depositary institutions for a purchase or a sale under the theory that this is a reasonable charge to create, assemble, or “issue”, and to cancel or “withdraw” the ADR from the stock held by the depositary. … We have reviewed the 20-Fs of a sample for twenty large ADR issuers by size of capitalization. Practically all of those indicate that the depositary charge is $5.00 per 100 ADRs, although some of the language suggests that it might be less than that. We believe the market power and size of a fund in order to negotiate that must be substantial, so for purposes of this analysis we have assumed that the $5.00 per 100 ADR “purchase” or “sale” is the prevailing price. On the other hand, we have not tried to incorporate into the additional pricing for ADRs what are obviously substantial incidental costs, namely the fee for keeping an account at a depositary (oftentimes $2.00 per ADR per year) or the additional charges for the processing of dividends which presumably occurs with some frequency, particularly with large capitalization stocks …. [I]f we look at international equity investments reflected for all funds described in Thomson’s, the amount of those assets are $819 billion and the amount to maintain that investment in ADRs, given their increased pricing, would amount to an additional “tax” for the use of American law of $2.2 billion. To impose this additional tax solely so Americans can utilize the laws that Congress has passed for their benefit is fundamentally unfair and puts funds and their fiduciaries in a fundamentally unfair position having to choose to pay increased costs for ADRs or to purchase international securities on foreign exchanges. 172

Further, one comment letter from an institutional investor stated that, when U.S. institutional investors acquire securities overseas, the transactional test will mean that they may need to “either become involved in foreign litigation to effectuate loss recovery or to forego its claims, potentially raising fiduciary concerns.”173

c. Transactional Test Forecloses Private Actions Involving Foreign Transactions in U.S. Listed Securities.

Comment letters also argued that a Section 10(b) private right of action should exist for purchasers who acquire overseas securities cross-listed on U.S. and foreign exchanges.174

172 Letter from Consolidated Retirement Fund, at 3, 5 (emphasis in original).

173 See, e.g., letter from CalSTRS. 174 See, e.g., letters from Leandro Perucchi; Forty-Two Law Professors; Israel Securities Authority. A comment letter from the Israel Securities Authority explicitly supported enforcing actions in U.S. court for securities that are cross-listed in Israel and the U.S. As the only government regulator that expressed such an opinion, the Israeli authority noted that, “[i]n our opinion, claimants who believe they have a valid claim under section 10(b) of the Securities Exchange Act against an issuer that has cross-listed its shares and the US regulation applies in the non-US market, should have a private right of action in the US irrespective of whether they

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According to a comment letter submitted by a group of law professors, “a compelling reason why [foreign] issuers … list securities on a U.S. exchange, and voluntarily subject themselves to filing periodic reports with the Commission, is that they increase the value of their securities globally by doing so. Issuers benefit by signaling their intention to comply with, and be subject to, U.S. securities laws.”175 This comment letter went on to conclude that, because these foreign issuers benefit from being listed in the United States, they should be held accountable to U.S. securities law standards – including Section 10(b) private rights of action – regardless of where a specific transaction occurs.

Further, some comment letters noted that the transactional test could arbitrarily disadvantage U.S. investors relative to foreign investors in situations where a fraud has occurred involving a U.S. and foreign cross-listed security.176 Specifically, if U.S. investors acquired their shares overseas but foreign investors acquired the same securities in the United States, the foreign investors could seek private redress under Section 10(b) while the U.S. investors would be denied similar recourse.

d. Transactional Test Fails to Account for Situations When U.S. Investors Are Induced to Purchase Securities Overseas.

A number of comment letters criticized the transactional test because it fails to protect U.S. investors who, while in the United States, are actively induced to enter into overseas securities transactions.177

purchased the relevant securities on the US domestic exchange or on the non-US exchange.” Israel Securities Authority, at 1.

Indeed, to press the point, one commenter discussed Justice Stevens’example from his Morrison concurrence concerning the foreign company that actively encourages “an unsophisticated retiree, on the basis of material misrepresentations, to invest her life savings in the company’s doomed securities,” but is “barred from seeking relief” as a result

175 Letter from Forty-Two Law Professors, at 9.

176 See, e.g., letters from CalPERS; Strathclyde; and NASCAT.

177 See, e.g., letters from New York State Comptroller; The London Pensions Fund Authority; Wirral MBC on Behalf of the Merseyside Pension Fund; Mn Services Vermogensbeheer B.V.; The Council of the Borough of South Tyneside Acting in Its Capacity as the Administering Authority of the Tyne and Wear Pension Fund; City of Bradford Metropolitan District Council as the Administering Authority for the West Yorkshire Pension Fund; Wolverhampton City Council, Administering Authority for the West Midlands Metropolitan Authorities Pension Fund (“London Pensions Fund et al.”); Maryland State Retirement and Pension System; Consolidated Retirement Fund; American Bar Association, Business Law Section (“ABA”).

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of the transactional test.178 These comment letters generally argued that such a result is both unfair and inconsistent with the investor protection objective of the U.S. securities laws.

C. Comments Concerning the Conduct and Effects Tests

1. Arguments in Favor of the Conduct and Effects Tests

In addition to asserting problematic aspects of the transactional test, many comment letters advanced a number of arguments in favor of the conduct and effects tests.179

a. Conduct and Effects Tests Better Serve Investor Protection and Improves Investor Confidence in the U.S. Securities Market.

A common argument advanced by the comment letters that supported enactment of the conduct and effects tests for Section 10(b) private actions is that doing so would promote investor protection through more vigorous enforcement of the federal securities laws.180 As one comment letter explained:

No one disputes that the limited resources available to the Commission renders the private enforcement of the federal securities laws a necessary tool to combat the scourge of securities fraud. Allowing only the Commission to bring actions in instances where the “conduct and effects test” is satisfied but the new restrictive “transactional” standard is not will cause, perversely, a disproportionate amount of Commission funds being diverted to address one of the most expensive species of securities fraud to investigate and prosecute – those cases that involve multiple nations with wide-flung witnesses and highly complex facts and issues.181

Several comment letters stated that affording private litigants the ability to bring Section 10(b) private actions under the conduct and effects tests would signal strong investor protection, thereby bolstering investor confidence in U.S. markets. These comment letters argued that this

178 Letter from CalPERS, at 2 (quoting Morrison v. National Australia Bank, 130 S. Ct.2869, 2895) (Stevens, J., concurring in the judgment)); see also letter from NASCAT, at 16.

179 Of the 39 comment letters supporting enactment of the conduct and effects test, 27 were from institutional investors, 7 were from law firms, 2 each were from investor organizations and academics, and 1 was from an individual investor.

180 See, e.g., letter from DRRT, at 3 (stating that “only a fraction of the damages are recovered by the SEC while contemporaneous or subsequent [private] civil enforcement actions return much bigger financial compensation to investors”).

181 Letter from London Pensions Fund, et al., at 2. See also Consolidated Retirement Fund.

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would in turn draw more investment to the United States and, thus, ensure that the benefits of reinstating the conduct and effects tests would outweigh the costs of doing so.182

b. Conduct and Effects Tests Reflect the Realities of Modern Global Business Organizations and Finance.

Many comment letters expressed the view that the conduct and effects tests better reflect the economic reality that a foreign company may have an extensive U.S. presence making it reasonable to subject the company to Section 10(b) private actions even though its shares may trade on a foreign exchange and the company may be incorporated overseas.183 Several comment letters observed that the U.S. presence may be so extensive – including in many cases wholly-owned U.S. subsidiaries that standing alone could be considered major U.S. corporations – that the foreign company may generally be perceived by U.S. investors as a de facto U.S. corporation.184 The comment letters expressed the view that it is particularly appropriate in these situations for the U.S. securities laws to afford investors a remedy when the conduct and effects tests are satisfied.185 According to one comment letter, where this is the case, the U.S. “securities laws should not be diminished simply because the stock purchase occurred on a foreign exchange.”186

182 See, e.g., Letter from Leandro Perucchi, at 8.

183 Letter from Consolidated Retirement Fund, at 9 (“[m]ultinationals who earn billions of dollars from Americans should not be insulated from fraud whether or not it is exported from our shores. Does one reasonably think that if you have billions of dollars of assets in the United States and receive billions of dollars of revenue from the United States and the fraud had a substantial connection to conduct in the United States, and it hurts a foreigner, will that foreigner think that America’s involvement is irrelevant?”).

184 In meetings with the Staff, representatives from pension funds discussed the issue of corporate structures and the perception of certain companies as de facto U.S. corporations. Memoranda regarding staff meetings with representatives from pension funds are included in the comment files referenced in footnote 44.

185 See, e.g., letter from New York State Comptroller (discussing on-going private securities litigation against BP, plc, which is incorporated in the U.K., but is the largest oil and gas producer in the United States, has 40% of its assets and workers in North America, and has 40% of its ordinary common shares owned by U.S. individuals and institutions).

186 Id. at 2-3.

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c. Conduct and Effects Tests Ensure that Fraudsters Either Operating in the United States or Targeting the United States Cannot Avoid the Reach of the U.S. Securities Laws Simply by Arranging for the Securities Transaction to Occur Overseas.

A number of comment letters suggested that the advantage of the conduct and effects tests are that these tests look to the overall nexus of the fraud with the United States in determining whether a Section 10(b) private action exists.187 As a result, those who would commit transnational securities frauds either executed from the United States or targeted at the United States can reasonably anticipate that they may face liability in a Section 10(b) action brought by the injured investors.

This advantage stands in marked contrast to the transactional test which, according to the comment letters, provides a clear roadmap for a fraudster seeking to escape private liability under Section 10(b) – i.e., structure the fraud so that even if its genesis, orchestration, and effects occur domestically, the securities transaction occurs outside the United States. One commentletter explained this view as follows:

Morrison tossed aside 40 years of time-tested jurisprudence relating to the “conduct and effects test” in favor of a “transactional” standard that looks solely at the locus of the transaction in question. Alarmingly, under Morrison it matters not whether the fraud committed is domestic or what the fraud’s domestic impact is, but instead depends upon a hyper-technical inquiry that elevates – above all else – the sole fact of where the transaction took place. By ignoring the fraud’s genesis or effect and focusing instead on the technical transaction, Morrisoncreates not just an easy escape for foreign fraudsters, but an open invitation: Come to the United States to commit securities fraud and feel free to negatively impact the United States with that fraud – so long as you don’t list your securities on an American exchange, you may never have to repay any of the investors you victimized. Through Morrison, the Supreme Court has strayed from the securities laws’ underpinnings of investor protection and largely denied investors – both domestic and foreign – the protections of the federal securities laws.188

Several comment letters identified pre-Morrison cases that, they explain, mightnot have survived in whole or in part under the transactional test, including In re Royal Dutch/Shell Transp. Sec. Litig., Civ. No. 04-374 (D.N.J.) (U.S. plaintiffs who purchased on both foreign and U.S. exchanges settled securities claims for in excess of $130 million), and In re Royal Ahold N.V. Sec. & ERISA Litig., No. Civ. 1:03-MD-01539 (D.

187 See, e.g., letters from Sunil Taparia and NASCAT.

188 Letter from London Pensions Fund, et al., at 3; see also letter from DRRT.

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Md.) (U.S and European investors who purchased stocks both on foreign and U.S. exchanges settled securities fraud claims for $1.1 billion).189

d. Conduct and Effects Tests Do Not Harm International Comity.

In contrast with the views generally expressed by the foreign governmental authorities in their Morrison briefs and comment letters to the Commission,190 some comment letters stated that enactment of the conduct and effects tests for Section 10(b) private actions would not harm international comity.191 Indeed, one comment letter asserted that application of the conduct and effects tests would, in fact, enhance international comity:

While some may contend that extension of a private right of action under the Exchange Act to transnational securities frauds would harm international relations based on comity, such an argument fails to credit substantive jurisprudential history and data and that counsels otherwise. … Neither we nor our counsel has uncovered a single instance where private securities fraud litigation on behalf of non-U.S. purchasers of non-U.S. securities on non-U.S. exchanges ha[s] ever been found to interfere with a non-U.S. sovereign’s ability to independently regulate its own securities markets. … Indeed, the policy of the Exchange Act – to protect investors, the integrity of capital markets, and the ability to raise capital in public

189 Letter from AGEST, et al., at 18-19 & n. 33. See also letter from NASCAT, at 31-32(listing cases that might have been resolved differently had the transactional test been applied, including: In re Paramalat Sec. Litig., MDL 1539 ($50 million settlement on behalf of a global class of shareholders); In re SCOR Holding (Switzerland) AG Litig., 04-CV-7897 (S.D.N.Y.) ($84.6 million settlement on behalf of purchasers of ADR purchasers anywhere in the world and ordinary share purchasers who resided in or were citizens of the United States); In re Bayer Secs. Litig., 03-1546 (S.D.N.Y.) ($18.5 million settlement on behalf of all purchasers on U.S. exchanges and U.S. purchasers on foreign exchanges); Wagner v. Barrick Gold Corp., 1:03-cv-4302 (S.D.N.Y.) ($24 million settlement on behalf of common stock purchasers on both the New York and Toronto stock exchanges)).

190 As discussed in the text accompanying footnote 146, supra, unlike other foreign national governmental authorities, the Israeli Securities Authority expressed the view that investors should be permitted to pursue a Section 10(b) private action against any issuer that has cross-listed its shares in the United States and Israel irrespective of whether they purchased the securities on a U.S. or Israeli exchange. See letter from ISA, at 1.

191 See, e.g., letters from CalSTRS, et al.; NASCAT; Leandro Perucchi; AGEST, et al.;Strathclyde.

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markets – is identical with and parallel to the policies of market regulators worldwide ….192

The comment letter further explained that:

Under the conduct and effects test, the federal securities laws protect non-U.S. investors harmed by a securities fraud exported from the United States, even where the issuer is a non-U.S. issuer and the stock transactions are executed on a non-U.S. exchange. As such the conduct and effects test is designed to prevent the United States from being used as a manufacturing base for the export of fraud and deceit. ... It is entirely appropriate for the federal securities laws to have extraterritorial application in situations demonstrating the export of fraud or deceit from the U.S. in the global securities markets, where there is substantial fraudulent conduct by top directors or executives in or throughout the United States, the direct effect of which caused harm to investors both in the U.S. and abroad. …193

2. Arguments Against the Conduct and Effects Tests

The comment letters that opposed enacting the conduct and effects tests incorporated the policy arguments that were raised in the Morrison briefs before the Supreme Court, discussed above in Sections II.C.2.c. and II.C.2.e. These arguments included concerns about impaired U.S. relations with other nations due to the cross-border extension of U.S. law, reduced foreign direct investment in the U.S. market, increased litigation costs, and diverted U.S. judicial resources.

In articulating their concerns with the conduct and effects tests, a number of commentletters asserted that the tests are unpredictable. The U.K. Government’s comment letter, for example, stated that application of the conduct and effects tests can “degenerate into an unpredictable collection of incompatible decisions and theories.”194 Another comment letter asserted that, as a consequence of this unpredictability, the “[pre-Morrison] U.S. litigation environment was having the predictable effect of depressing foreign willingness to invest in the United States.”195

192 Letter from Strathclyde, at 4-6 (citing Makoto Ikeya and Satoru Kishitani, Trends in Securities Litigation in Japan: 1998-2008, NERA ECONOMIC CONSULTING REPORT (July 15, 2009)).

Similarly, a comment letter stated that “extraterritorial application of the U.S. securities laws could have a chilling effect on foreign direct investment in the United

193 Id.

194 Letter from U.K. Government, at 4. See also letters from George T. Conway; SIFMA; U.S. Chamber of Commerce; Law Society of London.

195 Letter from U.S. Chamber of Commerce, at 34. See also letter from Skadden, Arps, Slate, Meagher & Flom LLP (“Skadden Arps”).

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States as well as capital formation in U.S. markets” because foreign issuers “fear that their investment could expose them to costly, distracting and potentially meritless U.S. securities fraud class actions based on securities transactions that occur outside the United States.”196

Additionally, a number of comment letters argued that investor protection and deterrence are sufficiently achieved in the context of transnational frauds by Congress having enacted the conduct and effects tests for Commission and DOJ enforcement actions.197 The comment letters also explained that different considerations underlying Section 10(b) private actions relative to Commission enforcement actions warrant retention of the transactional test for private actions.198

For example, the U.S. Chamber of Commerce stated that, “[i]n the past, the Commission has evinced an acute awareness of the dangers of intruding on foreign nations’ enforcement jurisdiction.” Private litigants, however, are primarily interested in obtaining a financial recovery and are more prone to pursue litigation in “circumstances that the government deems inappropriate or unjustified (because, for example, the law of the foreign nation provides a sufficient remedy).”199

Comment letters suggested a series of additional reasons why the conduct and effects tests are inappropriate for Section 10(b) private actions. First, one comment letter argued that it is unnecessary to enact the conduct and effects tests to protect small U.S. investors because they generally do not invest overseas.200 Second, a letter asserted that the conduct tests areparticularly inappropriate because these tests involve an arduous, fact-specific analysis that bears little relationship to investor expectations about whether they are protected by U.S. securities laws.201

196 Letter from Medef, at 3. See also letters from Skadden Arps; U.K. Government; Government of France; Australian Government; Vivendi.

Finally, a number of comment letters – including several from foreign national governmental authorities – argued that the conduct and effects tests are unnecessary for Section

197 See, e.g., letters from Government of France; U.S. Chamber of Commerce; Skadden; European Issuers. See also letter from Medef (explaining that transnational securities frauds are better pursued by the Commission rather than private litigants because the Commission has a greater understanding of international comity concerns).

198 Letter from U.S. Chamber of Commerce, at 29-33. See also letter from Medef, at 13-15.

199 Letter from U.S. Chamber of Commerce, at 30-31, 33. See also letter from Richard W. Painter.

200 See Letter from U.S. Chamber of Commerce. Retail investors tend to purchase ADRs domestically whereas U.S. institutional investors, which tend to purchase larger blocks of securities, generally do so in the local markets where the underlying foreign securities principally trade.

201 See Letter from EuropeanIssuers.

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10(b) private actions because many foreign legal regimes already provide sufficient remedies for investors.202

D. Alternative Approaches Proposed by Commenters

Several comment letters proposed alternatives to the pre-Morrison conduct and effects tests and the transactional test.203

1. Adoption of a Conduct and Effects Tests that Are Limited to U.S. Resident Investors

Although many comment letters argued that the pre-Morrison conduct and effects testsshould be available to both foreign and domestic investors,204 a number of comment letters supported enacting a modified version of the conduct and effects tests that would afford a Section 10(b) private action only for U.S. investors. 205 These comment letters generally argued that limiting the conduct and effects tests to U.S. investors would help to minimize some of the comity concerns.206 One letter supporting such an approach explained that “there is the strongest of connections” between the United States and its own citizens, which “the federal securities laws are designed to protect.” 207

202 See, e.g., letters from the Government of Australia; Government of France; Law Society of England & Wales and the City of London Law Society; Government of Federal Republic of Germany; HM Treasury, U.K. Government; European Commission; Government of Switzerland. But see, e.g., NASCAT (arguing that remedies available in other nations are deficient).

According to these comment letters, international comity

203 Several comment letters recognized the difficulty of identifying where a transaction takes place and suggested that a clarification through Commission rulemaking would bring much needed predictability. See letter from James B. Heaton, III and Hannah L. Buxbaum. Alternatively, one comment letter stated that the Commission could require that investors be provided with more disclosure about the implication of purchasing securities overseas. The letter suggested that the Commission “explore the need, if any, for a disclosure standard to ensure that investors making securities purchases and sale orders in the U.S. are made aware that non-U.S. law will govern those transactions executed abroad.” Letter from Atlantic Legal Foundation comment letter, at 11.

204 See, e.g., letters from Strathclyde; AGEST, et al.; Global Pension Fund.

205 See e.g., letters from NASCAT, Maryland State Retirement and Pension System, New York State, and Consolidated Retirement Fund.

206 See, e.g., letter from CalSTRS, et al., at 13. (“Allowing U.S. investors to bring Section 10(b) claims [using the conduct and effects test] against foreign issuers will not offend principles of international comity.”). See also letter from NASCAT, Maryland State Retirement and Pension System, New York State, and Consolidated Retirement Fund.

207 Id. at 14.

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recognizes that, just as foreign nations have a significant interest in determining what level of redress their own residents should receive, the United States has a significant and legitimate interest in making that determination for its citizens in the context of transnational securities, regardless of where the actual securities transaction occurred.208

Another comment letter argued that, because the conduct and effects tests require a nexus between the fraud and the United States, further restricting the tests’ applicability to U.S. investors should significantly alleviate any international comity concerns:

Where there is a material domestic component to the fraud, it is clear that providing a remedy to U.S. investors will not raise concerns about extraterritoriality or create a conflict between American and foreign law, even when the transaction took place on a foreign exchange. In most cases involving a U.S. investor, that material domestic component will exist since investment decisions will have been made in the U.S., fraudulent statements will have been received in the U.S., securities purchases and sales will have been initiated in the U.S., and harm will occur to entities resident in the U.S.209

But several comment letters from foreign pension funds argued that it would be unfair to differentiate between U.S. investors and foreign investors in enacting the conduct and effects tests:

The conduct and effects test inquiry focuses on whether the alleged wrongful conduct occurred in the U.S. or affects the U.S., not on who asserts the claim. The conduct and effects language is thereby consistent with the public policy that the law should be

208 One comment letter from a law professor explained that the two relatively unique features of U.S. law that foreign governments often identify – (1) the ‘opt-out’ system of U.S. class actions, and (2) the fraud-on-the-market theory in Section 10(b) private suits – make it problematic from an international comity perspective to enact a broad conduct test that would apply to foreign investors. See letter from Hannah L. Buxbaum, at 3-4. However, this comment letter further explained that enactment of the effects test would not present these concerns:

In my view, [the effects test] should be reinstated with respect to private actions …. Recognizing effects as a basis for the application of U.S. law is consistent with Morrison’s holding that U.S. law may be applied to fraud that affects a transaction taking place within the United States. Moreover, effects-based cases implicate the central regulatory interest of the United States: protecting U.S. markets and those who transact on them. They are therefore relatively unproblematic with respect to international comity.

209 Letter from CalSTRS, et al., at 13 (internal citations omitted). See also letters from NASCAT; Leandro Perucchi; AGEST, et al.

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equally applied to all and, as such, extending the extraterritorial cause of action to all investors comports with traditional notions of fairness.210

2. Adoption of a Fraud-in-the-Inducement Test

Several comment letters suggested a “fraud in inducement” test that would afford a Section 10(b) private remedy when fraudsters “reach into” the United States to induce a fraudulent domestic or foreign securities transaction.211 As one comment letter explained, this test would focus on “the location of the investor at the time the investor is induced to purchase or sell securities in reliance on a materially false or misleading statement or pursuant to a manipulative act.”212 The letter further explained that this proposed test is consistent with the expectation of investors, because “[i]nvestors would expect to be protected by the laws of the place they are present at the time they are subjected to false or misleading statements or manipulative conduct.”213

Relatedly, a comment letter from the lead counsel for the Morrison defendants, George T. Conway, proposed amendments to Section 10(b) that would afford a private action if both: (i) the misconduct has a nexus with the United States similar to the nexus required by the conduct and effects tests; and (ii) the “defendant solicited the transaction or directed manipulative or deceptive conduct specifically at the plaintiff” and the plaintiff actually relied on the misconduct.214

210 Letter from Strathclyde, at 3. As noted at footnote 144, a number of funds incorporated Strathclyde’s position by reference.

According to the letter, the proposal recognizes that “some extraterritorial

211 See e.g., letters from Forty-Two Law Professors; ABA; London Pension Funds.

212 Letter from ABA, at 3. See also letter from Forty-Two Law Professors, at 7 (highlighting the scenario where “a person in the U.S. is approached by brokers in the U.S. and is led to execute a trade on a foreign exchange” based on fraudulent information).

213 Letter from ABA, at 3. During a meeting with the Staff, a group of foreign institutional investors advised that foreign and domestic issuers have trade fairs and road shows in the United States in which these issuers provide information to funds and managers in the hopes of obtaining investments from these large investors. See July 12, 2011 Meeting with Representatives of European Pension Funds. Under a fraud in the inducement test, institutional investors (whether foreign or domestic) that make investments in reliance on fraudulent information provided at these events would presumably be able to pursue Section 10(b) private actions.

214 See letter from George T. Conway, at 4. The letter suggested adding the following legislative language at the end of Section 10(b):

Subsection (b) of this section, and rules promulgated under subsection (b) of this section, shall apply to domestic or extraterritorial conduct involving manipulative or deceptive

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application should be permitted, but should be … specifically restricted to circumstances in which the United States’ interest in redressing fraudulent conduct is the strongest.”215 Further, the letter explained that the proposal seeks to alleviate the international comity concerns that arise from application of the fraud-on-the-market presumption of reliance for securities fraud actions involving transactions occurring outside the United States.216

V. Options to Extend the Section 10(b) Private Action Extraterritorially

The Staff has carefully considered the views expressed in the comment letters that were submitted in response to the Commission’s request for public comment, as well as the views that were expressed in meetings that the Staff had with interested parties, in the Supreme Court briefs that were filed during the Morrison litigation, and in relevant scholarly literature. The Staff has also considered the pre- and post-Morrison case law.

The Staff offers a series of options for possible consideration. In Section A, the Staff discusses the conduct and effects tests. In Section B, the Staff discusses four other options that Congress might wish to consider.217

devices or contrivances in connection with any extraterritorial purchase or sale of any security, where either

In addition, a final option would be for Congress to take no

(1) conduct within the United States that constitutes substantial acts in furtherance of a manipulative or deceptive device or contrivance, or

(2) conduct outside the United States that has a substantial and reasonably foreseeable effect within the United States,

has occurred in connection with the purchase or sale; provided, however, that, in any private action arising under subsection (b) of this section, where the plaintiff seeks recovery of losses arising from any extraterritorial purchase or sale, the plaintiff shall be required to prove that the defendant solicited the purchase or sale or engaged in manipulative or deceptive conduct directed specifically at the plaintiff, and that either

(i) the plaintiff, while within the United States, actually relied upon manipulative or deceptive conduct of the defendant, or

(ii) the plaintiff, while outside the United States, actually relied upon manipulative or deceptive conduct of the defendant occurring inside the United States.

215 Id. at 3. 216 See id. at 5. 217 Section 929Y(b) of the Dodd-Frank Act discusses as one possible option extending private rights of action extraterritorially under Section 10(b) “just to institutional investors” such as pension funds and mutual funds, leaving other investors (including retail investors) with only

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action on this subject. Under that approach, the lower courts would continue to interpret and refine the Supreme Court’s holding in Morrison.

Further, the Staff believes that each of the specific options identified below is consistent with the recognized principles of prescriptive jurisdiction – i.e., legislative authority – as set forth in the Restatement (Third) of Foreign Relations Law of the United States.218 According to the Restatement of Foreign Relations Law, the United States has authority to prescribe law with respect to:

(1) (a) conduct that, wholly or in substantial part, takes place within its territory;

(b) the status of persons, or interests in things, present within its territory;

(c) conduct outside its territory that has or is intended to have substantial effect within its territory;

(2) the activities, interests, status, or relations of its nationals outside as well as within its territory; and

(3) certain conduct outside its territory by persons not its nationals that is directed against the security of the state or against a limited class of other state interests.219

the transactional test. The Staff found no support for such an approach either in the comment letters or during meetings with investors, including institutional investors.

218 RESTATEMENT OF FOREIGN RELATIONS LAW, supra note 13. The Restatement of Foreign Relations Law is one of the leading secondary authorities on international and foreign-relations law, and is also generally viewed as a persuasive authority on questions of international comity such as those implicated by the potential extraterritorial extension of a Section 10(b) private cause of action. The principles of prescriptive jurisdiction set forth in the Restatement of Foreign Relations Law seek to balance the competing interests of the United States and other jurisdictions in a manner that is consistent with international comity.

219 Id. § 402. Notwithstanding the foregoing, the Restatement of Foreign Relations Lawrecognizes limitations to ensure that the exercise of jurisdiction over a person or activity is reasonable. Id. § 403. Relevant factors include, among others, the “extent to which the activity takes place within the territory, or has substantial, direct, and foreseeable effect upon or in the territory,” id. § 403(2)(a), “the connections, such as nationality, residence, or economic activity, between the regulating state and the person principally responsible for the activity to be regulated, or between that state and those whom the regulation is designed to protect,” id. §403(2)(b), “the character of the activity to be regulated, the importance of regulation to the regulating state, the extent to which other states regulate such activities, and the degree to which the desirability of such regulation is generally accepted,” id. § 403(2)(c), “the extent to which

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In addition, the Restatement of Foreign Relations Law specifically provides that the United States may exercise authority to regulate activities related to securities if the securities transaction itself or the conduct related to the transaction occurs in the United States or, if such transaction or conduct takes place outside of the United States, if it has “a substantial effect on a securities market in the United States for securities of the same issuer or on holdings in such securities by United States nationals or residents.”220

A. Options Regarding the Conduct and Effects Tests

Much of this Study has been dedicated to identifying the various implications of extending to Section 10(b) private actions the conduct and effects tests that Congress enacted for Commission and DOJ enforcement actions – i.e., a conduct test that would extend Section 10(b) private actions to transnational securities frauds that involve “conduct within the United States that constitutes a significant step in furtherance of the [fraud], even if the securities transaction occurs outside the United States and involves only foreign investors”; and an effects test that would extend Section 10(b) private actions to transnational securities frauds that involve “conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”221

Having identified the various implications of extending Section 10(b) private actions under these standards, the Staff is of the view that enactment of the Commission and DOJ conduct and effects tests for Section 10(b) private actions would involve policy trade-offs that could carry significant implications in many areas, including investor protection and international comity. 222

another state may have an interest in regulating the activity,” id. § 403(2)(g), and “the likelihood of conflict with regulation by another state,” id. § 403(2)(h).

However, the Staff offers several alternative approaches that might

220 Id. § 416(2)(a).

221 Section 929Y(a) of the Dodd-Frank Act. 222 The Federal Securities Code, which was a proposal by the American Law Institute to revise the federal securities laws, provides one potential model for codification of the conduct and effects tests. See AMERICAN LAW INSTITUTE, FEDERAL SECURITIES CODE (1980). Section 1905(a)(1)(D)(ii) would apply United States law if some or all elements of an otherwise actionable conduct occur outside the United States but cause a “substantial effect” in this country “as a direct and reasonably foreseeable result.” Section 1905(a)(1)(D)(i) would apply United States law to actionable conduct that occurs “to a significant (but not necessarily predominant) extent within the United States.” Further, section 1905(c) would provide for a flexible administration of the extraterritorial scope of the securities laws by authorizing the Commission to make rules narrowing or broadening the scope of these provisions. See generally Louis Loss, Extraterritoriality in the Federal Securities Code, 20 HARV. INT’L L. J. 305, 308 (1979) (Code represents “blending” of judicial expertise in international law with the Commission’s expertise in rulemaking).

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alleviate certain of the potential negative consequences previously discussed that could result from enacting the broad conduct test set forth in Section 929Y. The Staff offers these alternatives particularly in light of the investor interest expressed in extending some form of a conduct and effects tests for Section 10(b) private actions.

One alternative approach is to adopt the conduct and effects tests, but to narrow the conduct test so that a private plaintiff seeking to base a Section 10(b) private action on it must demonstrate that the plaintiff’s injury resulted directly from conduct within the United States.223

This is the formulation of the conduct test that the Solicitor General, joined by the Commission, recommended in the Morrison litigation in the Supreme Court.224 The Commission has not altered its view in support of this standard.

Significantly, a conduct test with a direct injury requirement would further the strong federal interest in deterring fraudulent conduct that emanates from the United States.225 When fraudsters are masterminding and executing a securities fraud from within the United States, there seems little doubt that the resulting injuries that occur to investors outside the United States would be a direct result of the U.S. conduct.

Correspondingly, a direct injury requirement could serve as a filter to exclude those claims that have a closer connection to another jurisdiction and, thus, are more appropriately pursued elsewhere.226

223 The effects test – both as formulated in Section 929Y(a)(2) of the Dodd-Frank Act and as developed by the lower federal courts prior to the Morrison decision – includes the proximate causation concept of foreseeability, which ensures an element of reasonableness in the effects test’s application. This may explain in part why the effects test was relatively uncontroversial.See generally John H. Knox, The Unpredictable Presumption Against Extraterritoriality, 40 S.W. L. REV. 635, 640 (2011) (“The circuit courts saw less disagreement over the effects test, perhaps due to the simplicity of its application, or because the importance of extending securities laws abroad to protect against substantial effects in the United States seemed particularly compelling.”).

Indeed, the facts of the Morrison litigation demonstrate this. As the

224 See Brief for the United States, at 26 (Feb. 26, 2010) (available at 2010 WL 719337) (“[T]his Court should require a private plaintiff to establish not simply that his loss resulted from the fraudulent scheme as a whole, but that the loss resulted directly from the component of the fraud that occurred in the United States.”).

225 See generally discussion in footnote 97, supra, addressing the statement in Morrison, 130S. Ct. at 2886, that the United States in not being used as a “Barbary Coast” to perpetrate frauds on foreign securities markets.

226 It should be noted that early court of appeals’ decisions invoking the conduct test stated that Section 10(b) would not apply “to losses from sales of securities to foreigners outside the United States unless the acts (or culpable failures to act) within the United States directly cause[d] such losses.” Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 993 (2d Cir. 1975)

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Solicitor General explained, significant conduct in furtherance of the defendants’ fraud was alleged to have occurred in the United States – i.e., the fraudulent scheme was conceived in the United States and the false information that the Australian parent corporation ultimately released to the Australian public was generated here.227 This alleged domestic conduct would be sufficient to support a Commission or DOJ enforcement action under the conduct test enacted by Congress in Section 929P(b)(2) of the Dodd-Frank Act. However, the alleged fraudulent conduct in the United States was not a direct cause of the Australian investors’ injuries because, as the Solicitor General explained, there were a number of “significant intermediate events outside this country” between the generation of the false information here and the distribution of that information by the Australian parent corporation to Australian investors.228 As a result, the indirectness of the link between the alleged U.S. misconduct and the plaintiffs’ injury would preclude a Section 10(b) claim in this and similar circumstances under the “direct injury” version of the conduct test.229

Imposing a direct-injury requirement on private plaintiffs seeking to use the conduct test could have additional benefits identified by the Solicitor General during the Morrison litigation:

First, in contrast to Commission enforcement actions, which are unlikely to produce conflict with foreign nations,230 private actions under Section 10(b) “present a significant risk of conflict with foreign nations because the United States affords private plaintiffs litigation procedures and remedies that other countries often do not provide.”231

(Friendly, J.) (emphasis added). However, subsequent decisions generally appear not to have included a rigorous application of the direct cause standard. See, e.g., In re Alstom SA Securities Litig., 406 F. Supp. 2d 346, 373 (S.D.N.Y. 2005) (noting the “shift in emphasis from a test of strict causation”).

“Requiring private

227 Brief for the United States, at 30-31.

228 Id. at 31 (describing the intermediate events in Australia as review by various personnel of the parent corporation in Australia and distribution of the information by Australian personnel of the parent corporation who were “not acting under the direction and control” of individuals in the United States, “but rather were exercising independent judgment as officers” of the parent).

229 Importantly, the direct injury requirement should not be confused with an actual reliance requirement that would preclude use of the fraud-on-the-market theory to demonstrate reliance. Rather, the direct injury requirement would require that a plaintiff demonstrate a tight causal connection between the U.S. conduct and the foreign investors’ losses to maintain a Section 10(b) private action. That tight causal connection could be satisfied in situations where the fraudulent statements emanating from the United States impact the price of a security trading on a foreign exchange, irrespective of whether the foreign investors bringing suit actually relied on the fraudulent statements.

230 See discussion at Section II.C.2.d, supra.

231 Brief for the United States, at 26-27.

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plaintiffs to establish that their losses were a direct result of conduct in the United States mitigates that risk by limiting the availability of United States remedies to situations in which domestic conduct is closely linked to [their] grievance.”232

Second, a direct-injury requirement could reduce the risk that “the resources of United States courts will be diverted to redress securities-related harms having only an attenuated connection to this country.”233 In contrast to the Commission, which “can be expected to take account of national interests when it determines whether particular enforcement suits representssound uses of its resources and the resources of the federal courts,” private plaintiffs “have little incentive to consider whether resolution of their securities-related grievances represent a wise use of federal judicial resources” because their “overarching concern … is redressing their own injuries.”234

Notwithstanding the addition of a direct-injury requirement, extending Section 10(b) private actions under the conduct test could pose many of the same issues – albeit it to a reduced degree – that commenters and others have voiced with respect to the broader conduct test. There would still be some number of cases even with the direct causation requirement for which foreign investors receive remedies that their governments have determined not to provide, and this could pose challenges to international comity. These comity challenges could be particularly acute when the Section 10(b) private actions are brought by foreign investors against foreign issuers based on purchases or sales on a foreign exchange.

Finally, the direct-injury version of the conduct test could still require a fact-intensive inquiry involving burdensome discovery and other significant litigation efforts to determine if the alleged U.S. conduct constituted a direct cause of the overseas injury, which could impose increased costs on both U.S. courts and foreign corporations.

An additional option is to enact conduct and effects tests available just to U.S. investors.235 This approach may pose less of a challenge to international comity than conduct and effects tests available to all investors because international law generally recognizes that nations have a strong and legitimate sovereign interest in protecting their residents from frauds directed at them.236

232 Id. at 27.

233 Id. at 28.

234 Id.

235 See discussion in Section IV.D.1, supra.

236 See generally RESTATEMENT OF FOREIGN RELATIONS LAW, supra note 13, §§ 402, 416.

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Conduct and effects tests limited to U.S. investors would have the additional benefit of possibly fitting more closely with two of the principal regulatory interests of the U.S. securities laws – i.e., protection of U.S. investors and U.S. markets – than the transactional test.237 For example, considering Justice Stevens’ example of the foreign issuer that goes door to door fraudulently inducing U.S. investors to purchase the issuer’s stock on a foreign exchange, conduct and effects tests available for U.S. investors would provide these U.S. investors a remedy in the event securities fraud occurred. As another example, a Section 10(b) private action would be available for U.S. investors who are defrauded in connection with overseas securities transactions by their securities intermediaries – i.e., broker-dealers and investment advisers.238

But conduct and effects tests limited to U.S. investors would not be without potential drawbacks. Significant among these are the potential for (i) costly discovery and ad-hoc factual analysis before any determination as to whether Section 10(b) reaches the conduct, and (ii) application of Section 10(b) to securities transactions that occur on foreign securities exchanges, which a number of foreign governmental authorities have opposed.

B. Options to Supplement and Clarify the Transactional Test

In addition to considering whether the conduct and effects tests should be applied to Section 10(b) private actions, the Study is to consider whether “a narrower extraterritorial standard” than the conduct and effects tests might be appropriate. Accordingly, the Staff offersthe following options that Congress may wish to consider.

1. Permit Investors to Pursue a Section 10(b) Private Action for the Purchase or Sale of any Security that Is of the SameClass of Securities Registered in the United States,Irrespective of the Actual Location of the Transaction

Investors could be expressly permitted to bring a private action whenever there is a violation of Section 10(b) involving a security that is of the same class of securities registered in the United States without regard to the location of the actual transaction.239

When any issuer – domestic or foreign – registers a class of securities with the Commission, that issuer agrees to the obligations and conditions imposed by the federal securities laws, including the antifraud obligations of Section 10(b). By affording a cause of

237 Letter from Hannah L. Buxbaum.

238 In addition, these scenarios could also be addressed by reinstating the effects test.

239 As discussed in Section III.A, supra, there is disagreement regarding prong 1 of the transactional test – i.e., is it sufficient that a plaintiff engaged in a transaction involving a security that is listed on a U.S. exchange, irrespective of where the actual transaction occurs, or must the plaintiff in fact have traded the security on the U.S. exchange.

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action for all investors in that class of securities – and not just those who may have purchased or sold in the United States – the potential deterrent effect that results from the private liability might be enhanced, which in turn could reduce the overall incidence of Section 10(b) violations.

As a further benefit of permitting private actions for all investors in a security, the class of which was registered in the United States, U.S. institutional investors might be able todiversify their securities holdings with respect to cross-listed securities without, as discussed above, having to decide between the potential additional costs and burdens of acquiring exchange-traded ADRs in the United States, on the one hand, or foregoing a Section 10(b) private action by purchasing the underlying reference securities on an overseas exchange.240 In addition, a standard based on U.S. registration would provide a bright line that would permit any issuer considering U.S. registration to estimate the potential liability exposure and to proceed accordingly.

Additionally, registration of a class of securities for trading on an exchange could be seen as an appropriate trigger to determine the availability of a Section 10(b) private action. A company that has registered its class of securities has developed a significant connection to the U.S. securities markets. It has either listed its securities on a U.S. exchange or has both more than five hundred shareholders of record (and at least three hundred shareholders in the United States)241 and ten million dollars in total assets.242 Focusing on registration would ensure that investors will retain the ability to pursue Section 10(b) claims against those companies that have sought to access the public U.S. securities markets and are meeting the reporting and disclosure requirements of U.S. securities law.243

But private liability based solely on registration could be perceived as disruptive to international comity. This is particularly so because this approach could result in a return to U.S. courts of so-called “foreign-cubed” class actions – i.e., private class actions brought by foreign investors suing foreign issuers involving transactions on foreign exchanges. Indeed, under a

240 As discussed in Appendix A, infra, when ADRs are listed on a national securities exchange, the foreign issuer must register the class of underlying securities under the Exchange Act.

241 See Exchange Act Rule 12g3-2, 17 C.F.R. § 240.12g3-2.

242 See Exchange Act Rule 12g-1, 17 C.F.R. § 240.12g-1.

243 The registration standard may not sufficiently protect the interests of U.S. investors in all situations where foreign issuers avail themselves of the U.S. markets to raise money from U.S. investors. For example, foreign issuers could raise a significant amount of capital from U.S. investors in transactions that are exempt from the registration requirements of the Securities Act involving securities that are not of a class registered under the Exchange Act. If the Congress were to enact the registration standard, the Commission should be given rulemaking authority to deal with other situations where foreign issuers avail themselves of the U.S. markets to raise money from U.S. investors.

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U.S.-registration standard, the Morrison litigation itself would have been decided differently because, as discussed below in Appendix B, defendant National Australia Bank’s stock was registered in the United States.

In addition, there is a risk that a U.S.-registration standard could discourage foreign issuers from registering securities in the United States because doing so could expose foreign issuers to so-called global securities class actions – i.e., class actions that comprise investors from all nations that purchased the company’s securities on any securities exchange. This could negatively impact the competitiveness of the United States capital markets. Relatedly, this could impair U.S. investors’ ability to directly acquire foreign securities domestically – particularly U.S. retail investors’ ability to acquire ADRs – if a significant number of foreign issuers avoided the U.S. securities market. Although the probability of this occurring is unclear, the Staff notes that foreign issuers actively pursued U.S. registration for forty years notwithstanding the potential Section 10(b) private liability, which could indicate that foreign issuers would generally continue to do so under a U.S.-registration standard.

2. Authorize Section 10(b) Private Actions Against Securities Intermediaries that Engage in Securities Fraud While Purchasing or Selling Securities Overseas for U.S. Investors

As discussed above, several federal district court cases have held that a securities intermediary – e.g., a broker-dealer244 or investment adviser – that defrauds a customer or client in connection with a foreign securities transaction may avoid Section 10(b) private liability under the transactional test, even if the intermediary is physically operating in the United States or actively providing services to U.S. investors. If this application of the transactional test stands, it would create a void in the Section 10(b) private liability regime that unscrupulous securities intermediaries could abuse.245

To prevent this risk, Congress may wish to consider affording a Section 10(b) private action against: (i) securities intermediaries located within the United States when they defraud a client in connection with any securities transaction (i.e., foreign or domestic); and (ii) foreign securities intermediaries when they are reaching into the United States to provide securities

244 Customers of a U.S.-registered broker-dealer may still be able to pursue other claims through FINRA arbitration proceedings. See generallyhttp://www.finra.org/ArbitrationMediation/Parties/Overview/.

245 To illustrate this point, consider the example of a U.S. broker-dealer that seeks to defraud its U.S. and foreign customers. The broker-dealer could advise its customer to purchase or sell a U.S. security, and then steal the customers’ money rather than execute the transactions. Under this scheme, the broker-dealer would be subject to Section 10(b) private liability because the fraud was in connection with a domestic securities transaction. See generally SEC v. Zandford,535 U.S. 813 (2002). However, if the U.S. broker-dealer modifies the scheme slightly to instead advise its customer to purchase securities on a foreign exchange, and then steals the money, the transactional test may preclude private liability under Section 10(b).

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investment services for a U.S. client and commit fraud against that client in connection with any securities transaction.246

Such an approach would likely not offend principles of international comity given the significant U.S. interest in ensuring that securities intermediaries either physically operating here or reaching into the United States market to provide services for U.S. clients do not engage in fraud. Indeed, where a U.S.-based securities intermediary commits fraud against a U.S. client in connection with an overseas securities transaction, it is arguably the case that only the United States would have a sovereign interest implicated by the fraud.

3. Permit Investors to Pursue a Section 10(b) Private Action if They Can Demonstrate that They Were Induced While in the United States to Engage in the Transaction, Irrespective of Where the Actual Transaction Occurred

Congress may also wish to consider a “fraud in the inducement” test similar to that suggested by a number of comment letters.247 Under such a test, an investor could purse a Section 10(b) private action if the investor is in the United States “at the time the investor is induced [by the fraudster] to purchase or sell securities in reliance on a materially false or misleading statement or pursuant to a manipulative act.”248 A benefit of this approach is that it could help deter both domestic and foreign parties from targeting persons in the United States with deceptive or manipulative actions while those persons are present here (a limitation that Justice Stevens’s concurrence identified with the transactional test’s scope), lest they face a potential Section 10(b) private action. 249

246 This standard could be tailored to apply to only those broker-dealers and investment advisers that are required to register with the Commission, or it could also include those intermediaries that are exempt from registration. See generally Exchange Act Rule 15a-6, 17 C.F.R. § 240.15a-6.

247 See discussion in Section IV.D.2, supra.

248 Letter from ABA, at 3.

249 See discussion in Part II.C.3, supra. It seems fair to observe that Justice Stevens’s concern is already being realized. For example, in In re Royal Bank of Scotland Group plc Securities Litigation, plaintiffs were U.S. investors that claimed that one of the fraudulent transactions affected by defendant Royal Bank of Scotland involved securities sold to them in a rights offer. 765 F. Supp. 2d 327, 336 (S.D.N.Y. 2011). A rights offer is a capital raising undertaken by an issuer in which the issuer extends to its existing security holders the opportunity to purchase additional securities from the issuer. Plaintiffs claimed that the offering document prepared by the defendant bank specifically for the rights offer was subject to liability under Section 10(b). The court, however, found otherwise, stating that “Morrison is dispositive as to the Rights Issue claims as … [it] did not involve a domestic securities transaction.” Id. at 339. Thus, at least one court has found that a direct offer and sale by a foreign issuer to U.S.

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A fraud-in-the-inducement standard likely would not raise significant international comity concerns. First, as discussed above, the United States has a strong and well-recognized interest in ensuring that fraudulent conduct is not directed at investors in the United States. Second, a fraud-in-the-inducement standard would require a showing that the investor was actually induced in the United States by the deceptive communications or devices. By definition, therefore, the standard would require a demonstration of actual reliance when it is invoked to support a Section 10(b) private action, precluding use of the “fraud on the market” theory that has been a source of criticism from foreign government authorities when it is applied to transnational securities frauds involving overseas transactions.

4. Clarify that an Off-Exchange Transaction Takes Place in the United States if Either Party Made the Offer to Sell or Purchase, or Accepted the Offer to Sell or Purchase, While in the United States

As discussed above, the Supreme Court’s Morrison decision did not specify when an off-exchange transaction takes place in the United States, and as a result the lower federal courts have been struggling to determine when an off-exchange transaction occurs here. One approach that at least two court decisions have applied involves a fact-intensive inquiry that looks to whether the moment of irrevocable liability occurred in the United States.250 Yet, an“irrevocable liability” or similar narrow standard would cut against the bright-line purposes underlying the transactional test, and it could also serve as a roadmap for overseas fraudsters to structure transactions to avoid Section 10(b) private liability. As an example of the latter, consider a U.S.-based issuer that solicits off-exchange securities transactions by sending U.S. investors a sales subscription agreement and, in an attempt to escape Section 10(b) private liability, directs the U.S. investors to fax back the signed agreement to the issuer’s off-shore agent, who then signs the sales agreement outside the United States on behalf of the U.S. issuer.

For these reasons, if Congress determines to legislate in this area, a statutory clarification of the transactional test’s application to off-exchange transactions would be useful. Specifically, Congress might clarify that, in the case of off-exchange transactions, a domestic securities transaction occurs if a party to the transaction is in the United States either at the time that party made the offer to sell or purchase, or accepted the offer to sell or purchase.251

investors is not subject to Section 10(b) private liability, the scenario contemplated by Justice Stevens.

This clarification would be consistent with the Morrison decision’s intention to establish a bright-line standardbecause this clarification would provide a readily apparent answer as to whether the parties can

250 See discussion in Section III.H, supra.

251 This is essentially the standard employed in the Uniform Securities Act. See Uniform Securities Act § 610 (as amended in 2002) (available at http://apps.americanbar.org/buslaw/newsletter/0009/materials/uniformsecure.pdf ).

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resort to a Section 10(b) private action. This clarification would have the following additional benefits: it would reduce the risk that fraudsters will attempt to structure off-exchange transactions so that the moment of irrevocable liability occurs outside the United States; it isconsistent with modern contract theory which recognizes that a contractual arrangement such as a sales or purchase transaction can occur in both of the jurisdictions where the parties are located at the time of contracting;252 and it reflects investor expectations because investors generally appear to expect that the law of the jurisdiction where they are located when they enter an off-exchange securities transaction will protect them.

Finally, this clarification for off-exchange transactions should not present international comity concerns because the United States has a strong and well-recognized interest in redressing fraud that occurs in transnational securities transactions that involve U.S. parties.

VI. Conclusion

In Morrison v. National Australia Bank, the Supreme Court eliminated the availability of Section 10(b) private actions for victims of transnational securities frauds that relate to overseas transactions. Congress responded both by adding Section 929P(b)(2) to codify the conduct and effects tests for Commission and DOJ actions involving transnational securities fraud and by directing that the Commission seek public comment and issue this Study to consider similarly extending the cross-border scope of Section 10(b) private rights of action. This Study has attempted to identify the relevant policy considerations that Congress might want to consider as part of a process for determining whether to enact legislation regarding the cross-border scope of Section 10(b) private actions.

Whether the cross-border scope of Section 10(b) private actions is ultimately addressed through legislation, further judicial developments, or both, this area will be subject to further

252 As the Third Circuit Court of Appeals has explained:

At one time, it was fashionable to conceive of contracts between diverse parties as being rooted in a single geographical location, such as the place the offer was accepted. Under this traditional approach, it was believed that when a contract offer made in New Jersey was accepted in New York, the contract was “made” in New York, and thus implicated New York’s sovereignty. The contrasting modern approach is to recognize that contracts formed between citizens in different states implicate the regulatory interests of both states. Thus, when an offer is made in one state and accepted in another, we now recognize that elements of the transaction have occurred in each state, and that both states have an interest in regulating the terms and performance of the contract.

A.S. Goldmen & Co., Inc. v. New Jersey Bureau of Securities, 163 F.3d 780, 787 (3d Cir. 1999) (internal citations omitted). See also Lintz v. Carey Manor Ltd., 613 F. Supp. 543, 550 (W.D. Va. 1985) (“[S]o long as there is some territorial nexus to a particular transaction, the laws of two or more states may simultaneously apply.”).

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legal development in the years ahead. Absent legislation, lower federal courts in particular will likely be called upon to resolve myriad novel and difficult issues regarding the application of the new transactional test.

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BIBLIOGRAPHY

In preparing the Study, the Staff generally consulted as background the following secondary sources:

Treatises, Books and Other Non-periodic Materials

EXTRATERRITORIAL JURISDICTION IN THEORY AND PRACTICE (Karl M. Meessen ed., 1996).

RESTATEMENT (THIRD) OF FOREIGN RELATIONS LAW OF THE UNITED STATES (1987).

AMERICAN LAW INSTITUTE, FEDERAL SECURITIES CODE (1980).

Post-Morrison v. National Australia Bank Law Review Articles

Joshua L. Boehm, Note, Private Securities Litigation After Morrison v. National Australia Bank:Reconsidering a Reliance-Based Approach to Extraterritoriality, 53 HARV. INT’L L. J. 501(2012).

Hannah L. Buxbaum, Remedies for Foreign Investors Under U.S. Federal Securities Law, 75 LAW & CONTEMP. PROBS. 101 (2011).

Roger W. Kirby, Access to United States Courts by Purchasers of Foreign Listed Securities in the Aftermath of Morrison v. National Australia Bank Ltd., 7 HASTINGS BUS. L. J. 223 (2011).

Elizabeth Cosenza, Paradise Lost: § 10(b) After Morrison v. National Australia Bank, 11 CHI. J.INT’L L. 343 (2011).

John H. Knox, The Unpredictable Presumption Against Extraterritoriality, 40 S.W. L. REV. 635 (2011).

Richard Painter, Douglas Dunham, & Ellen Quackenbos, When Courts and Congress Don’t Say What They Mean: Initial Reactions to Morrison v. National Australia Bank and to theExtraterritorial Jurisdiction Provisions of the Dodd-Frank Act, 20 MINN. J. INTL. L. 1 (2011).

Genevieve Beyea, Morrison v. National Australia Bank and the Future of Extraterritorial Application of the U.S. Securities Laws, 72 OHIO ST. L. J. 537 (2011).

Andrew Rocks, Notes, Whoops! The Imminent Reconciliation of U.S. Securities Laws with International Comity after Morrison v. National Australia Bank and the Drafting Error in the Dodd-Frank Act, 56 VILL. L. REV. 163 (2011).

Meny Elgadeh, Note, Morrison v. National Australia Bank: Life After Dodd-Frank, 16 FORDHAM J. CORP. & FIN. L. 573 (2011).

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Lauren Macias, Case Note, The “Transactional Test” Replaces the “Conduct and Effects Test” When Determining the Extraterritorial Reach of Private Rights of Action Pursuant to Section 10(b) of the Securities Exchange Act of 1934: Robert Morrison, et al., v. National Australia Bank Ltd., 13 DUQ. BUS. L. J. 75 (2011).

James Wilson, One Year Later: The Reach of U.S. Securities Laws After Morrison, LEXIS-NEXIS EMERGING ISSUES ANALYSIS, May 25, 2011, available at LEXIS, 2011 Emerging Issues 5668.

Pre-Morrison v. National Australia Bank Law Review Articles

Erez Reuveni, Extraterritoriality as Standing: A Standing Theory of the Extraterritorial Application of the Securities Laws, 43 U.C. DAVIS L. REV. 1071 (2010).

Jonathan Wang, Comment, Securities Pirates: Why a More Expansive Basis for Jurisdiction Over Transnational Securities Fraud Will Prevent the United States from Turning into the Barbary Coast, 62 ADMIN. L. REV. 223 (2010).

Danielle Kantor, Note, The Limits of Federal Jurisdiction and the F-Cubed Case: Adjudicating Transnational Securities Disputes in Federal Courts, 65 N.Y.U. ANN. SURV. AM. L. 839 (2010).

Stephen J. Choi & Linda J. Silberman, Symposium, Transnational Litigation and Global Securities Class-Action Lawsuits, 2009 WIS. L. REV. 465 (2009).

Luigi Zingales, The Future of Securities Regulation, 47 J. ACCOUNTING RESEARCH 391 (2009).

Joel R. Paul, The Transformation of International Comity, 71 LAW & CONTEMP. PROBS. 19 (2008).

Howell E. Jackson & Eric J. Pan, Regulatory Competition in International Securities Markets: Evidence from Europe - Part II, 3 VA. L. & BUS. REV. 207 (2008).

Peter M. Saparoff & Katharine C. Beattie, The Benefits of Including Foreign Investors in U.S. Securities Class Action Suits, SN084 A.L.I.-A.B.A. 669 (2008).

Hannah L. Buxbaum, Multinational Class Actions Under Federal Securities Law: Managing Jurisdictional Conflict, 46 COLUM. J. TRANSNAT’L L. 14 (2007).

John C. Coffee, Jr., Foreign Issuers Fear Global Class Actions, NAT’L L.J. (June 14, 2007).

W. Barton Patterson, Note, Defining the Reach of the Securities Exchange Act: Extraterritorial Application of the Antifraud Provisions, 74 FORDHAM L. REV. 213 (2005).

Brandy L. Fulkerson, Note, Extraterritorial Jurisdiction and U.S. Securities Law: Seeking Limits for Application of the 10(b) and 10b-5 Antifraud Provisions, 92 KY. L. J. 1051 (2003-2004).

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Kun Young Chang, Multinational Enforcement of U.S. Securities Laws: The Need for the Clear and Restrained Scope of Extraterritorial Subject-Matter Jurisdiction, 9 FORDHAM J. CORP. &FIN. L. 89 (2003).

Katherine J. Fick, Comment, Such Stuff as Laws are Made on: Interpreting the Exchange Act to Reach Transnational Fraud, 2001 U. CHI. LEGAL F. 441 (2001).

Joshua G. Urquhart, Comment, Transnational Securities Fraud Regulation: Problems and Solutions, 1 CHI. J. INT’L L. 471 (2000).

Michael J. Calhoun, Comment, Tension on the High Seas of Transnational Securities Fraud: Broadening the Scope of United States Jurisdiction, 30 LOY. U. CHI. L. J. 679 (1999).

John D. Kelly, Note, Let There Be Fraud (Abroad): A Proposal for a New U.S. Jurisprudence with Regard to the Extraterritorial Application of the Anti-Fraud Provisions of the 1933 and 1934 Securities Acts, 28 LAW & POL’Y INT’L BUS. 477 (1997).

Stephen J. Choi & Andrew T. Guzman, The Dangerous Extraterritoriality of American Securities Laws, 17 NW. J. INT’L L. & BUS. 207 (1996).

Philip R. Wolf, International Securities Fraud: Extraterritorial Subject Matter Jurisdiction, 8 N.Y. INT’L L. REV. 1 (1995).

Sidney G. Wigfall, Subject Matter Jurisdiction in Transnational Securities Fraud Cases: The Second Circuit’s Extraterritorial Application of the 1934 Exchange Act and Congressional Intent, 5 TOURO INT’L L. REV. 233 (1994).

Kellye Y. Testy, Comity and Cooperation: Securities Regulation in a Global Marketplace, 45 ALA. L. REV. 927 (1994).

Margaret V. Sachs, The International Reach of Rule 10b-5: The Myth of Congressional Silence,28 COLUM. J. TRANSNAT’L L. 677 (1990).

Gregory K. Matson, Note & Comment, Restricting the Jurisdiction of American Courts Over Transnational Securities Fraud, 79 GEO. L. J. 141 (1990).

Eric D. Peterson, Note, Transnational Securities Fraud Jurisdiction Under Section 10(b): The Case for a Flexible and Expansive Approach, 47 WASH. & LEE L. REV. 637 (1990).

Louise Corso, Note, Section 10(b) and Transnational Securities Fraud: A Legislative Proposal to Establish a Standard for Extraterritorial Subject Matter Jurisdiction, 23 GEO. WASH. J. INT’L L.& ECON. 573 (1989).

Louis Loss, Extraterritoriality in the Federal Securities Code, 20 HARV. INT’L L. J. 305 (1979).

APPENDIX C


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APPENDIX A

Regulatory Framework for American Depositary Receipts

U.S. investors often hold equity securities of foreign issuers (other than Canadian issuers) in the form of American depositary receipts (“ADRs”). An ADR1 is a negotiable security that represents an ownership interest in a specified number of foreign securities that have been placed with a depositary financial institution by the holders of such securities. An ADR is in essence a substitute trading mechanism for foreign securities – the holder can transfer title to the underlying foreign securities by delivery of the ADR. The securities that are deposited with the depositary (“deposited securities”) typically are equity securities, although debt securities have been deposited securities on rare occasions. The depositary is typically a U.S. bank or trust company, and it usually appoints a custodian to hold the deposited securities in the home market of the foreign issuer. The custodian is often a bank, and may be a subsidiary or branch of the depositary or a third-party institution with which the depositary has a contractual custodian relationship.

The ADR mechanism was developed in the early part of the twentieth century to overcome or mitigate certain legal, technical and practical problems confronting U.S. investors that wanted to effect transactions in foreign securities. The use of ADRs obviated the need to record transfers of ownership of foreign securities on share registers maintained outside the United States, and it also made it easier to handle equity securities in bearer form, which were common outside the United States. An ADR may represent one security of a foreign issuer or fractions or multiples of a security of a foreign issuer.2

1 The Commission’s regulations distinguish between ADRs and American depositary shares (“ADSs”). Under these regulations, an ADR is the physical certificate that evidences ADSs (in much the same way a stock certificate evidences shares of stock), and an ADS is the security that represents an ownership interest in the deposited securities (in much the same way a share of stock represents an ownership interest in a corporation). It appears, however, that ADR market participants largely do not differentiate between ADRs and ADSs. As a result, the term “ADS” is not used in this Study, and the term “ADR” may, depending on its context, refer to either the physical certificate or the security evidenced by such certificate.

2 The ratio of such securities represented by one ADR (referred to by market participants as the “multiple”) compensates for differences between traditional pricing levels in the United States and those of foreign markets. When creating an ADR facility, the depositary and the issuer determine the ratio of securities represented by one ADR to establish a price per ADR that would be attractive to U.S. investors. For example, for ADRs representing securities that traditionally trade in a foreign market at low per share prices as compared with the U.S. market, one ADR may represent two, five or more underlying shares of the foreign issuer to arrive at a price per ADR that falls within the expected trading range for securities trading on a specified U.S. market. Conversely, for ADRs representing securities that traditionally trade in a foreign market at high per share prices as compared with the U.S. market, one ADR may represent one-half, one-fifth or smaller fraction of the underlying shares of the foreign issuer to arrive at a price

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The ADR arrangement provides U.S. investors3 with several attributes that are absent in direct ownership of foreign securities. The depositary (or the custodian) monitors the declaration of dividends, collects them and converts them to U.S. dollars for distribution. In addition, the clearance and settlement process for ADRs generally is the same as for other domestic securities that are traded in the U.S. markets. Thus, investors can own an interest in securities of foreign issuers while holding securities that trade, clear and settle within automated U.S. systems and within U.S. timeframes. In essence, ADRs have many characteristics of a domestic equity security.

Sponsored and Unsponsored ADR Facilities

ADR facilities may be established as either “sponsored” or “unsponsored.” While ADRs issued under these two types of facilities are similar in some respects, there are distinctions between them relating to the rights and obligations of ADR holders and the practices of market participants.4 Although the terms of deposit for sponsored and unsponsored ADR facilities differ, sponsorship in and of itself does not result in different reporting or registration requirements with the Commission.

Unsponsored Facilities

“Unsponsored” ADR facilities generally are created in response to interest on the part of some investors, a broker-dealer and a depositary. A depositary may establish an unsponsored facility without participation by (or even the acquiescence of) the issuer of the deposited securities. Once a registration statement registering the ADRs has been filed with the Commission and has become effective, the depositary may begin to accept deposits of the foreign securities and to issue ADRs against such deposits.

Holders of unsponsored ADRs generally bear all the costs of such facilities. The depositary usually charges fees upon the deposit and withdrawal of deposited securities, the conversion of dividends into U.S. dollars, the disposition of a non-cash distribution, and the performance of other services. The depositary of an unsponsored facility frequently is under no obligation to distribute shareholder communications received from the issuer of the deposited securities or to pass through voting rights to ADR holders in respect of the deposited securities.

Unsponsored ADR facilities are usually duplicated; that is, after one depositary has established a facility for a particular issuer’s securities, other depositaries often establish their

per ADR that falls within the expected trading range for securities trading on a specified U.S. market.

3 Although originally developed for U.S. investors, foreign investors may also hold ADRs.

4 Some of these differences are inherent to the two different ADR types, i.e., they are a function of the different levels of issuer involvement. Other differences are attributable largely to industry custom and practice.

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own facilities for the same class of that issuer’s securities. Such duplication can occur without the approval of either the foreign issuer or the original depositary. Duplicate unsponsored ADRs generally are considered fungible with each other and trade without regard to the identity of the depositary.

Sponsored Facilities

A “sponsored” ADR facility is established jointly by an issuer and a depositary.5

Sponsored ADR facilities are created in generally the same manner as unsponsored facilities, except that the foreign issuer of the deposited securities enters into a deposit agreement with the depositary and signs the registration statement under the Securities Act. The deposit agreement sets out the rights and responsibilities of the issuer, the depositary and the ADR holders. Each ADR holder becomes a party to such agreement through its holding of the ADR.

With sponsored facilities, the issuer of the deposited securities generally agrees contractually to bear some of the costs relating to the facility, such as costs associated with the distribution of dividends, although ADR holders continue to pay other costs, such as deposit and withdrawal fees. Under the terms of some sponsored arrangements, depositaries agree to distribute notice of shareholder meetings and voting instructions, thereby facilitating the ability of ADR holders to exercise voting rights. In addition, the depositary may agree to distribute shareholder communications and other information to the ADR holders at the request and cost of the foreign issuer of the deposited securities.

The ADR Market

ADRs are traded in the United States in substantially the same manner as the equity securities of domestic issuers. Some foreign issuers choose to list their ADRs on a U.S. stock exchange, such as the New York Stock Exchange, NYSE-Amex, or Nasdaq Stock Market. Other foreign issuers choose to have trading in their ADRs conducted in the U.S. over-the-counter market.

Regulatory Treatment

Securities Act Registration. The definition of “security” in the Securities Act states that the term “security” means “any … stock, … certificate of deposit for a security, … or, in general

5 Market participants describe sponsored facilities in terms of three categories, based on the extent to which the issuer of the deposited securities has accessed the U.S. securities market. A “Level 1 facility” is a sponsored ADR facility the ADRs of which trade in the U.S. over-the-counter market and the foreign issuer is not registered with or reporting to the Commission under Section 12 or 15 of the Exchange Act. “Level 2” refers to sponsored ADRs that are listed on a U.S. stock exchange (and thus the foreign issuer has registered under Section 12 of the Exchange Act) but the foreign issuer has not sold ADRs in the United States in order to raise capital or effect an acquisition. “Level 3” denotes sponsored ADRs that are listed on a U.S. stock exchange where the foreign issuer has sold ADRs in the United States in a registered public offering.

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any interest or instrument commonly known as a security, … [or any] receipt for … any of the foregoing.” As a result, for purposes of the Securities Act, ADRs and the deposited securities are considered as separate securities, each subject to the registration requirements under the Securities Act. When a foreign issuer is making a public offering of its securities in the United States, the securities generally must be registered with the Commission under the Securities Act. While the issuer may choose to sell such securities in ADR form, the use of ADRs to facilitate a public offering does not supplant the need for the foreign issuer to register its securities – both the ADRs and the deposited securities must be registered.

Beyond circumstances where the foreign issuer is engaged in a public offering of the deposited securities, registration of the foreign issuer’s securities generally is not required. For example, a person who purchased securities of a foreign issuer on a foreign stock exchange in an ordinary secondary market transaction would generally be able to resell those securities in the United States without registration in reliance on an exemption.6 The fact that this person may decide to deposit the securities into an ADR facility, create ADRs and then resell the ADRs in the United States would not alter the applicability of the exemption to the resale of the underlying securities in the form of ADRs. However, the issuance of ADRs upon such a deposit would involve a public offering of the ADRs and that transaction must be registered.

The Commission has adopted a special registration scheme specifically for the registration of ADRs under the Securities Act – Form F-6. This form elicits disclosure of the terms of deposit relating to the ADRs, such as: the number or fraction of underlying securities represented by an ADR; procedures for dividend collection and distribution; procedures for voting, transmission of shareholder notices, lending arrangements, fees and charges relating to the ADRs; and any restrictions upon the right to withdraw and deposit underlying securities. The form does not elicit any information about the foreign issuer itself, such as its financial statements or a description of its business.

Exchange Act Registration and Reporting. In general, there is no direct reporting requirement on the part of the foreign issuer of the deposited securities that results solely from the establishment of a sponsored ADR facility or a depositary’s establishment of an unsponsored ADR facility. When ADRs are listed on a national securities exchange, however, the foreign issuer must register the class of underlying securities under the Exchange Act and, in so doing, becomes subject to the Exchange Act’s reporting requirements.7

6 See, e.g., Section 4(1) of the Securities Act, 15 U.S.C. 77d(1) (providing an exemption from registration for transactions by persons other than the issuer, underwriters and dealers); Section 4(3) of the Securities Act, 15 U.S.C. 77d(3) (providing an exemption from registration for certain transactions by dealers following a distribution).

7 Under Exchange Act Rule 12a-8, the ADRs themselves are exempt from registration under the Exchange Act. See 17 C.F.R. § 240.12a-8.

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APPENDIX B

Economic Research on the Costs and Benefits ofExtending a Private Right of Action for Transnational Securities Frauds

I. Introduction

This Appendix describes the economic consequences of a cross-border extension of a Section 10(b) private right of action in transnational securities. To understand the costs and benefits of a cross-border extension, we both reviewed the findings from existing economic research and empirically analyzed the stock price reactions of U.S. cross-listed companies to news of the U.S. Supreme Court’s June 24, 2010 decision in Morrison v. National Australia Bank Ltd.1 Our empirical analysis does not show a statistically significant stock price reaction to the decision. Considering both the existing economic research and the results of our analysis, we are unable to document evidence of either economic costs or economic benefits that could be clearly and directly linked to extending a private right of action.2

II. Expected Economic Effects

A. Effects on the Number of Eligible Investors and the Size of a Class

For purposes of this analysis, we assume that if Congress were to extend a cross-borderprivate right of action for transnational securities frauds, the extension would expand the number of investors who would be eligible to participate in a class action for transnational securities frauds. Expanding the pool of eligible investors would, in turn, increase the number of investors who would choose to participate in private class action lawsuits against companies whose shares are listed on non-U.S. exchanges, particularly among those investors who purchased their shares in non-U.S. markets.3

1 130 S. Ct. 2869 (2010). 2 There are two other recent empirical studies on the Morrison decision available in the public comment file http://www.sec.gov/comments/4-617/4-617.shtml. Licht, Poliquin, Siegel and Li (2011) provided a preliminary study with evidence that Morrison positively affected stock prices of foreign firms, which would be evidence against the benefits of a cross-border extension. The results provided in Gagnon and Karolyi (2011) suggest that investors moved trading from the home market to the US to obtain class-action protections, evidence in favor of benefits of a cross-border extension. 3 The overall effect of increase in the size of a class may be less than one-to-one becausethe transaction costs of communicating with investors who had purchased in non-U.S. markets may be greater than the costs of communicating with investors who purchased in the U.S. market.

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B. Effects on Settlement Amounts and Filing Rates for Private Class Actions

A direct effect of a cross-border extension would be to increase the expected size of the class by increasing the number of eligible shareholders. As long as shareholders that purchase shares overseas have some positive likelihood of filing a claim, adding these investors to a class would cause an increase in the amount actually paid in a settlement.4 Therefore, by increasing the number of eligible investors, holding all else equal, a cross-border extension would increase both the estimated aggregate damages and the amount actually paid in settlement for litigation against companies that are listed both on U.S. exchanges and abroad.5

It is also significant that the payoffs for plaintiff’s attorneys for settled cases are usually directly related to the amount of the settlement.6 As a result, increasing the size of the eligible class and therefore the potential settlement would likely increase the incentives for plaintiff’s attorneys to bring a lawsuit. Consequently, there could be an increase in the number of lawsuitsas well.7 Consistent with this expectation, economists have found that the likelihood of a class action lawsuit, and particularly the likelihood of a class action lawsuit against foreign firms, is positively related to the number of affected shares.8

As regards the incentives of corporations that may be the targets of class action suits, the increase in settlement sizes might lead them to exert greater effort to avoid being the subject of a class action. For example, by increasing the expected settlement amount for a given lawsuit, across-border extension could benefit investors by providing a deterrent effect on managerial

4 See, e.g., Crew, N., et al., Securities Act Violations: Estimation of Damages, LITIGATION SERVICES HANDBOOK: THE ROLE OF THE FINANCIAL EXPERT, ch.17 (3rd ed.) (Weil et al. eds.).Although actual claimed losses may be uncorrelated with estimated losses based on proportional trading models (see Fischel, Ross, and Keable (2006)), an increase in the size of the class would be expected to have a direct effect on the number of filed claims. 5 Consistent with this position, two papers have noted that the Morrison decision reduced the legal protections for shareholders of foreign companies. E.g., Buckberg and Gulker (2011)(“We conclude that, following Morrison, foreign companies’ expected litigation costs should fall, because investors who purchased their shares on overseas exchanges will be excluded from classes, driving down damages and settlements.”); Licht, Poliquin, Siegel and Li (2011) (stating that, post-Morrison, “U.S.-listed foreign private issuers (“FPIs”) (also referred to in the literature simply as cross-listed firms) thus were suddenly shielded from civil claims by investors who purchased their shares on their home markets.”). 6 See, e.g., Eisenberg and Miller (2010). 7 See Buckberg and Gulker (2011) (stating that “by driving down the entire distribution of expected settlement sizes and expected fee awards, Morrison may also reduce the aggressiveness with which the plaintiffs’ bar pursues foreign issuer complaints, further driving down foreign issuer settlements”). 8 Field, Lowry, and Shu (2005); Gande and Miller (2011).

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behavior.9 Improving deterrence would limit managerial expropriation which, in turn, would be expected to reduce the number of violations. The cross-border extension, therefore, could improve shareholder welfare by increasing the cost of managerial misbehavior. This may indicate fewer lawsuits in the aggregate.

C. Effects on Weak or Meritless Lawsuits

There is a risk that an increase in the ability of shareholders to bring a Section 10(b) class action in securities fraud under the cross-border extension, and the potential for larger resulting awards or settlements, could lead investors and others to pursue weaker or even unmeritorious cases in the hope of settling with corporations that are risk-averse and have much to lose from negative publicity. The effect of these class action lawsuits could be both a transfer of capital and a deadweight cost. The transfer is from current shareholders of the defendant corporation to a particular subset of shareholders who effected certain transactions on a particular day. The transfer is accompanied by a deadweight cost because the attorney representing the class is expected to get a significant fraction of the settlement amount.10 To the extent that this type of weak or meritless lawsuit gets filed and settled more frequently, one economic effect of the cross-border extension is an increased frequency of such transfers and deadweight costs on current shareholders.

It is unclear whether the increase in the size of the class, potential settlements and the probability of lawsuit would be outweighed by the deterrent effect on managers.11 There are legitimate arguments in both directions.

D. Effects on Trading Volume

The cross-border extension may also affect the incentives of investors to trade on non-U.S. exchanges rather than U.S. exchanges. A cross-sectional study by Halling et al. (2007) indicates that for cross-listed firms, trading volume on U.S. exchanges is higher for companies from countries with poor investor protections.12

9 Since the penalties in securities class action lawsuits are borne (mostly) by shareholders rather than managers, whether they achieve an optimal level of managerial deterrence for their costs is controversial. See, e.g., Fox (2011); Coffee (2006). The question of deterrence is discussed further as the “bonding hypothesis” in the following section on the valuation effect of cross-listings.

To the extent that the Morrison decision reduced the scope of protection available to investors who trade outside the U.S., all else equal, investors may have a stronger incentive to execute trades within the United States. As a result,

10 See, e.g., Eisenberg and Miller (2010). 11 Some threshold evidence on the effect of limiting the extraterritorial reach of private class action lawsuits was provided by Buckberg and Gulker (2011), who reported that “filings against foreign companies have not decreased since the Morrison decision in June 2010.” 12 Similar results are reported in a study of institutional investors’ holdings of American Depositary Receipts (“ADRs”) by Aggarwal et al. (2007).

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Morrison could have a positive effect on U.S. trading volume. Consistent with this expectation, Buckberg and Gulker (2011)—citing Halling et al. (2007), claim that, post-Morrison, “at least some institutional investors are likely to request that their trades in cross-listed stocks be executed in the U.S.” The implication of these studies is that a cross-border extension of a Section 10(b) private right of action might cause an expected decline in U.S. trading volume,though this has not yet been empirically tested.

It is important to note that a private right of action is only one of many factors that affect trading volume on U.S. and non-U.S. exchanges for cross-listed securities. Because of the complexity of factors affecting trading volume and execution decisions, the practical significance of the impact on trading volume on U.S. exchange of a cross-border extension is not clear.

III. Empirical Evidence: Research on U.S. Cross-Listings

Another question raised by the proposed cross-border extension is whether greater exposure to U.S. securities laws and regulations would cause an increase in firm value. The primary focus on whether a firm can increase value through bonding to U.S. securities laws has been on studies of cross-listings. Many of these studies have concluded that there is a valuation premium associated with cross-listing a foreign firm on a U.S. exchange (for reviews of the research, see Karolyi, 2011 and Karolyi, 2006).13

In addition to a possible valuation premium, evidence of bonding includes improved corporate governance for firms that cross-list on U.S. exchanges. Specifically, economists have found evidence of a reduced cost of capital (see, e.g., Hail and Leuz, 2009), higher-valued excess cash holdings (see Fresard and Salva, 2010), and even CEO terminations in poorly-performing firms (see Lel and Miller, 2008).

Notwithstanding the evidence of potential benefits to a foreign issuer from listing in the United States, because private rights of actions are just one component of the U.S. securities regulations, we do not have sufficient evidence to conclude that the existence and effects of across-border extension would have a net beneficial effect on firm value. Simply put, cross-listing on a U.S. exchange entails many other economic effects, and may be motivated for many reasons beyond simply exposing the firm to U.S. securities law and regulation.

A. Evidence of the Valuation Benefits of U.S. Cross-Listings

Several studies have identified a valuation premium associated with a U.S. listing. At least three different methods have been used. The first method is an event study, which is a statistical technique used to assess the effects of an economic event on the value of firms.14

13 This Appendix is not comprehensive in its coverage of the existing research.

Some of the early studies use the event studies method to analyze stock price reactions to the announcement of depositary receipt programs (see, e.g., Foerster and Karolyi, 1999, and Miller,

14 See, e.g., MacKinlay (1997).

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1999). One such study (Miller, 1999) found a statistically significant positive announcement effect of 1.27% for firms cross-listing on over-the-counter markets (“OTC”), and a larger effect of 2.63% for firms cross-listing on the NYSE or NASDAQ.

The second method compares Tobin’s q for cross-listed and non-cross-listed foreign companies. Tobin’s q is the ratio of the market value of a firm’s assets to the replacement value of those assets. A higher value of Tobin’s q is interpreted as an indicator of superior managerial performance and better growth opportunities.15 Using this approach, Doidge, Karolyi, and Stulz (2004) found that Tobin’s q for U.S. cross-listed foreign companies were 16.5% higher than Tobin’s q of non-cross-listed peers. 16

A third approach assesses the valuation benefits of a U.S. cross-listing. Hail and Leuz (2009) analyzed the implied cost of capital for firms that cross-list to U.S. exchanges and the OTC by comparing them to the implied costs for non-cross-listed peers. A lower relative implied cost of capital for U.S. cross-listed firms is a valid measure of the valuation premium for the U.S. listing. They found that the estimated benefits ranged from a 70 to 120 basis point reduction in the cost of capital for firms cross-listing onto an exchange, and from 30 to 70 basis points for firms that are cross-listed in the OTC markets. In addition, they found that there were no similar results indicating a reduction in the cost of capital for firms cross-listing on the London Stock Exchange. The reduction in the cost of capital supports the hypothesis that there is a valuation increase associated with the cross-listing event.

In light of all the factors affecting company valuations at the time of a cross-listing, however, they concluded that their analysis “does not provide an estimate of the fraction of the cross-listing premium that can be attributed directly to listing.”

Additional recent research indicates that the valuation premium associated with a U.S. cross-listing may not be unique to the United States. Sarkissian and Schill (2011) studied 2,838 listings from 69 home markets that list abroad in 32 host markets. They found that a foreign issuer’s valuation premium associated with cross-listing in the U.S. was comparable with the valuation premium associated with cross-listing to a market in Japan, France, or Switzerland. Further, they found that U.S. firms that cross-list onto non-U.S. exchanges in Germany, Japan, and other markets (except Canada), experience a statistically significant valuation premium. These results suggest that the valuation benefits associated with a U.S. cross-listing may not be caused by the U.S. legal and regulatory environment.

In summary, although the results from these analytical approaches provide evidence of a cross-listing valuation premium, the Sarkissian and Schill analysis suggests that the cross-listingpremium is not unique to the United States. More importantly, none of these studies indicatesthat the cross-listing valuation premium is attributable to the U.S. securities-law private rights of action specifically. As a result, these studies have not yet provided direct evidence regarding the cross-border extension of the private right of action.

15 Ross, Westerfield, and Jaffe (2005), p. 41; Grinblatt and Titman (1998), p. 684. 16 Doidge et al. measured Tobin’s q as the total book value of assets minus book equity plus market value of equity, all divided by the total book value of assets. They considered only firms with total book value of assets greater than $100 million.

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B. Evidence of Improved Corporate Governance from a U.S. Cross-Listing

There are several different reasons why stock prices might be expected to increase with the announcement of a U.S. cross-listing.17 One reason, which has been labeled the “bonding hypothesis,” is that, by exposing the firm to legal protections for shareholders, disclosure requirements,18 and increased monitoring from analysts and bankers,19 a cross-listing enables managers to credibly commit that they will not expropriate the firm’s resources or defraud minority investors.

Several economists have found evidence consistent with the bonding hypothesis. For instance, Lel and Miller (2008) found that firms from weak investor protection regimes that are cross-listed on a U.S. exchange are more likely to terminate a poorly performing CEO. Their results are consistent with the theory that U.S. cross-listed foreign firms are more committed to disciplining senior management than their non-cross-listed foreign peers.20 They also found that prior to cross-listing, there was no significant relationship between CEO turnover and CEO performance.

Providing further evidence of a link between U.S. cross-listing and corporate governance, Fresard and Salva (2010) found that excess cash balances on foreign company balance sheets had a higher valuation for U.S. cross-listed firms than for their non-cross-listed foreign peers. These results are consistent with the theory that cash balances created a larger increase in shareholder value for cross-listed firms, suggesting stronger corporate governance. In another study, 17 Coffee (2002) provides a detailed description and analysis. 18 Although there is extensive research on the economic costs and benefits of U.S.disclosure requirements, the net economic impact of these requirements is not clear. See, e.g.,Leuz and Wysocki (2008); Beyer et al. (2010)). 19 At least two studies have reported an increase in analyst coverage associated with a U.S.cross-listing. For instance, Lang, Lins, and Miller (2003) found that, after controlling for firm size, country, and industry, firms that cross list in the United States and reconcile to U.S. GAAP have an average of two to three more analysts covering the firm, and the average analyst earnings forecast is more accurate than non-U.S. firms that are not cross-listed. Furthermore, they find that analyst coverage and higher forecast accuracy are associated with a higher Tobin’s q ratio. Baker, Nofsinger, and Weaver (2002) also found evidence of an increase in analyst coverage. 20 Lel and Miller do not find that cross-listing to the U.S. OTC provides any improvement in the likelihood of terminating a poorly performing CEO. However, companies cross-listed onOTC markets, which face reduced disclosure requirements relative to exchange-listed firms, could be sued in a shareholder class action during the period of their study (1992-2003), subject to the limitations of the conduct and effects tests. Therefore, their results do not provide evidence that private class action protections for shareholders produce improved corporate governance.

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economists found that, when controlling shareholders have high levels of control, their firms are less likely to be cross-listed to a U.S. exchange (Doidge, Karolyi, Lins, Miller and Stulz, 2009). This suggests that foreign companies with greater opportunities for controlling shareholders to expropriate firm assets are less likely to cross-list, consistent with the theory that a U.S. cross-listing tends to impose limitations on opportunities for expropriation.

However, an improvement in corporate governance is just one among many economic factors that might cause a U.S. cross-listing premium. Economists have also found evidence that firms with U.S. cross-listings obtain: (a) better access to larger capital markets (“segmentation hypothesis”), (b) increased liquidity for shareholders, (c) increased visibility (“recognition hypothesis”), and (d) an improvement in price discovery (“information channel”).21 In addition, many economists have suggested that the observed valuation premium could actually motivate firms to cross-list, or that an unobserved factor might cause both the valuation premium and the cross-listing. This has been described by economists as a ‘selection bias’ issue, which affects nearly all studies on the valuation and corporate governance effects of cross-listings.22

One recent study takes a unique approach to examine companies that would have been unaffected by the selection bias associated with the firm’s decision to cross-list, by studying a group of firms that reflect an alternative selection bias. The authors study firms that were selected by a depositary bank for Level 1 ADR’s,23 causing an involuntary cross-listing onto OTC markets (Iliev, Miller, and Roth, 2011). They found that firms experience a significant decrease in Tobin’s q after being involuntarily cross-listed.24 Although the involuntary cross-listing would not cause the firms to be subject to U.S. disclosure requirements, it might increase the firm’s U.S. class action litigation risk. The authors found that, with the involuntary cross-listing, audit fees for these companies increased by nine percent and the firm value declined by six percent. For these firms, it appears that the increased litigation risk associated with an involuntary U.S. listing might have a net negative, rather than a positive, effect on valuations.25

21 For a review of some of these studies, see Karolyi and Gagnon, 2010. See also Foucault and Gehrig (2008); Fernandes and Ferreira (2008); Foucault and Fresard (2011). 22 See generally Bailey et al. (2006) (noting that “larger, more leveraged, faster growing firms are more likely to list”). See also, e.g., Karolyi (2011); Doidge, Karolyi, and Stulz (2004);Sarkissian and Schill (2011). 23 See discussion of ADRs in Appendix A, supra. 24 The authors found that depositary banks selected large, profitable, high valuation firms from countries with better protections for minority investors and stronger disclosure requirements. 25 One interpretation consistent with these results is that firms are heterogeneous in terms of the potential benefits that they face in cross-listing, with the possibility that some firms could end up incurring more costs than benefits. Therefore, firms that do choose to cross-list in the U.S. may reap a cross-listing premium but those that are involuntarily listed – who rationally did not themselves choose to list – may actually experience a decrease in their firm values.

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Regardless, even if there were a consensus in the literature that U.S. cross-listed firms improve their corporate governance as a direct result of the cross-listing, more research would be required to conclusively determine if the improvement to corporate governance would be a sufficient basis for extraterritorially extending the Section 10(b) private right of action. The reasons for the improvement in corporate governance and the potential contribution of a U.S. private right of action would remain unclear as this hypothesis has not been directly tested by the prior literature. Indeed, even if there were a clear improvement in corporate governance that was directly caused by a U.S. listing, the available evidence does not rule out the possibility that the Section 10(b) private right of action might have a negative effect on company value (albeit a negative effect that is netted out by the countervailing positive effects of the U.S. dual-listing).

IV. Potential Shareholder Wealth Effects of a Cross-border Extension: Evidence from the Time Period Surrounding the Morrison Oral Argument and Decision

As discussed above, although there are many economic studies that analyze the economic impact of cross-listing, the evidence that they provide on the economic costs and benefits of extraterritorially extending a private right of action for transnational securities frauds is indirect and inconclusive. However, Morrison itself provides an opportunity to test for a market impact of restricting private rights of action for securities fraud.26

Specifically, we assess the economic consequences of the decision by analyzing the net-of-market stock price reactions of U.S.-listed foreign firms on March 29, 2010, the date of the oral arguments in Morrison, and on June 24, 2010, the date of the decision.27 In doing so, wetest the hypothesis that, by excluding transactions on non-U.S. exchanges from participation in private class actions, Morrison had an effect on the value of U.S.-listed foreign companies.

As discussed below, we do not find a statistically significant stock price reaction in response to either the decision or the oral arguments in Morrison. Our analysis of the data provides no evidence that the Morrison decision resulted in statistically significant costs or

26 This analysis follows the approach of Licht, Poliquin, Siegel and Li (2011), which was submitted during the public comment period. Our analysis stems from their insight and approach, although our conclusions are different. Karolyi and Gagnon (2011) study the effects of the Morrison decision by analyzing the spread between ADR and home market securities prices. 27 We look in particular at the oral arguments because, according to some observers, the Supreme Court effectively communicated the direction of the ultimate decision. See, e.g.,Goldhaber, Michael, “Out of Gas; During Its Four-Year Pursuit of Volkswagen, Little Porsche Outmaneuvered the Giant Carmaker – But then Sputtered at the Finish. Were Porsche’s Lawyers to Blame?” AMERICAN LAWYER (May 1, 2010) (“The U.S. Court of Appeals for the Second Circuit adopted a relatively narrow rule on F-cubed jurisdiction in Morrison v. National Australia Bank, and most observers expect that rule to narrow further after the U.S. Supreme Court decides that case this term.”).

APPENDIX C


B9

benefits on shareholders of foreign companies that were listed on U.S. and non-U.S. securities exchanges.

A. Data

We test the hypothesis that the trading price of a company that is simultaneously listed on both U.S. and non-U.S. exchanges is affected by news of either the oral argument or the decision. Because there are multiple different ways to identify foreign firms, we take four different approaches:28

• Set 1 uses 966 companies that were identified by the Commission as international registered and reporting companies as of December 31, 2009. We removed from this listthe following: one duplicate, six companies that are identified as NYSE-Debt and NYSE-Preferred, 32 companies due to lack of daily returns data,29 and 284 companies that the SEC identifies as “OTC”, leaving a total of 643 companies.

• Set 2 includes these 643 companies and adds 90 companies that are identified as either ADRs or companies incorporated outside the U.S. by CRSP as of March 29, 2010, producing a list of 733 companies.30

• Set 3 begins with the list of 643 companies from the SEC list, and removes 51 companies that are not listed on an exchange outside the U.S., producing a set of 592 companies.31

• Set 4 begins with the 592 companies and removes 179 companies for which the only non-U.S. exchange listing is in Germany, but the company is not incorporated in Germany,32

28 We have posted the names and tickers for the companies included in each of the four sets. They may be obtained from the public comment file for this study.

which leaves 413 companies.

http://www.sec.gov/comments/4-617/4-617.shtml 29 Specifically, we require that the daily stock file from the Center for Research in Securities Prices (“CRSP”) must include a daily return on at least one of the event dates and it must include at least 60 days of daily returns between 3/29/2008 and 3/26/2010. 30 We identify a company as a foreign issuer when the CRSP share type code has a first digit equal to “3” or a share type code equal to “12”. Of our sample of 643 original companies, 623 were identified as foreign issuers by CRSP. The remaining 20 companies were identified as international registered and reporting companies by the SEC. We eliminated five companies that were identified as foreign issuers by CRSP, because Standard and Poor’s Compustat identified these companies as U.S.-based. 31 We used Datastream as well as the October 2011, Citigroup ADR list to identify foreignlistings.

APPENDIX C


B10

Table 1: Number of Non-U.S. Companies, by Country This table shows the distribution of the sample datasets across 50 countries. Companies are assigned to countries based on the Commission’s list of International Registered and Reporting Companies (“SEC List”) or, where this information is not available, based on Standard and Poor’s Compustat.

Set #1 Set #2 Set #3 Set #4

Country

SEC List subject to data

availability, excluding OTC

Set #1 pluscompanies with

ADRs or non-U.S. incorporation

Set #1 excludingcompanies

not listed outside U.S.

Set #3 excludingcompanies with low

trading volume outside the U.S.

Antigua 1 1 1 0Argentina 13 13 13 13Australia 9 9 9 9Bahamas 1 2 1 0Belgium 2 2 2 2Bermuda 21 53 20 7Brazil 15 15 15 15British Virgin Islands 25 26 22 0Canada 173 177 152 141Cayman Islands 78 87 71 1Chile 11 12 11 11China 11 11 11 11Colombia 1 1 1 1Denmark 2 2 2 2Finland 1 1 1 1France 9 9 9 7Germany 7 7 7 7Greece 3 3 3 3Hong Kong 5 5 5 4Hungary 1 1 1 1India 13 13 13 11Indonesia 2 2 2 2Ireland 8 18 7 6Israel 60 61 55 37Italy 5 5 5 3Japan 21 21 21 21Korea 10 10 10 9Liberia 2 3 1 0Luxembourg 5 6 5 3Marshall Islands 25 28 21 1Mexico 18 21 17 17Netherlands 15 18 13 9Netherlands Antilles 1 3 1 1New Zealand 1 1 1 1Norway 1 1 1 1Panama 2 3 2 0Papua New Guinea 1 1 0 0Peru 1 1 1 1Philippines 1 1 1 1Portugal 1 1 1 1Russia 3 4 3 3Singapore 1 4 1 0

32 We exclude the non-German companies that are listed on a German exchange because we are concerned that low trading volume for these firms could bias our test against finding an effect.

APPENDIX C


B11

South Africa 6 6 6 6Spain 5 5 5 4Sweden 1 1 1 1Switzerland 6 15 5 5Taiwan 6 6 5 5Turkey 1 1 1 1United Kingdom 32 36 30 27Totals 643 733 592 413

The distribution of the four datasets by country is provided in Table 1. The differences across the datasets are primarily due to companies incorporated in the Cayman Islands, Bermuda, Canada, the Marshall Islands, the British Virgin Islands, Israel, Ireland, and Switzerland.

B. Results

We consider the U.S. stock exchange returns for each of the four sets of non-U.S.companies on March 29, 2010, the date of the oral arguments for Morrison, and June 24, 2010,the date of the decision. To test the significance of the returns on those dates, after adjusting for market movements, we utilize a “portfolio method” event study to calculate abnormal returns for each of the four sets of foreign companies.33 To adjust for the cross-sectional correlation in abnormal returns induced by the simultaneous effect on all of the companies in the sample, weform an equally-weighted portfolio of the companies in each dataset, and estimate the abnormal returns by running a regression of the portfolio returns on a proxy for returns on the market (the S&P 500 index). We used a two year estimation period immediately preceding the date of the oral arguments, from March 29, 2008 to March 26, 2010. The regression results are provided in Table 2, Panel A, and are strongly consistent across the different data sets. The estimated betas are very close to one, and the R-squared statistic shows that approximately 80% of the variability in the portfolios is explained by the market proxy.34 These portfolios are highly correlated with the S&P 500 index.

As a point of reference, we compared the results of these regressions to regression results for the S&P 500 over the same estimation period on four different international stock indices: the Vanguard FTSE All-World ex-US Index (VFWIX), the Vanguard Total World Stock Index ETF (VT), the iShares MSCI EAFE Index (EFA), and the iShares MSCI All Country World Index (ACWI). The results for these indices, provided in Table 3, were similar, with betas closer to one, and slightly higher R-squared statistics.35

33 The “portfolio method” is similar to a Fama-MacBeth regression, and is described in detail by Sefcik and Thompson (1986).

The comparison suggests that the strong

34 For each of these regressions, the root mean squared error (“RMSE”) is approximately 1%, so, as a rough estimate, the absolute value of an estimated abnormal return would need to be approximately 2% to be statistically significant. This threshold far exceeds the estimated abnormal returns on the event study dates. 35 The RMSE for the regressions on these indices ranges from 0.67% to 0.93%, indicating that the threshold for statistical significance is that the absolute value of abnormal returns would exceed 1.3% to 1.8%.

APPENDIX C


B12

correlation with the S&P 500 is not induced by a cross-listing effect, but instead reflects correlation across economic factors driving broad portfolio returns.

Table 2, Panel B, shows the abnormal returns for each portfolio and date, defined as the difference between the portfolio actual returns and the predicted returns based on the marketmodel. 36 On March 29, 2010, we find abnormal returns ranging from 0.27% to 0.28% that are not statistically significant. 37 On June 24, 2010, we find abnormal returns ranging from 0.00%to 0.08% that are not statistically significant. As a reasonableness check on the statistical results, Chart 1 shows the daily abnormal returns data for 2010 using the portfolio method. The portfolio used in this chart is the one identified as Set #4, the SEC list of international registered and reporting companies as of December 31, 2009, after excluding OTC firms and other companies that are not listed on non-U.S. exchanges, as described above. The chart provides a visual confirmation that the abnormal returns on the dates of the oral arguments and the decision are not unusual. In fact, the abnormal returns on March 29, 2010, are in the 74th percentile and the results on June 24, 2010, are in the 42nd percentile. The chart and the percentile calculations support the validity of the statistical results.

In addition to using the portfolio method to test for statistical significance, we estimate abnormal returns using a Brown and Warner (1985) approach and obtain similar results, also shown in Table 2. The Brown and Warner results are based on running a market model regression for each company in each dataset during the same two year estimation period. The same market proxy is used, but an additional restriction is applied to reduce the effects of outlier returns: all returns that have an absolute value in excess of 25% are excluded from the estimation period. The Brown and Warner abnormal returns are slightly larger than the abnormal returns calculated using the portfolio method, and are also not statistically significant.

Because March 29, 2010, falls on a Monday, the one-day returns on March 29th actually represent the return between the close of trading on Friday March 26th and the close of trading on Monday March 29th. As a result, any firm-specific or portfolio-specific weekend news would presumably have affected the abnormal returns. Because the oral arguments did not begin until 11:07 a.m. on March 29th, we believe that abnormal returns that took place between the close of trading on March 26th and 11:00 a.m. on March 29th should not be attributed to the Morrisoncase. 36 Although several newswires ran articles describing the oral arguments on March 29th, 2010, neither the Wall Street Journal nor the New York Times carried an article that mentioned the Morrison case on March 30th. When the decision was announced on June 24th, 2010, there was a similar lack of newspaper coverage on the following day. In contrast, when the Supreme Court decision in the Janus Capital case was announced on June 13, 2011, the Wall Street Journal, New York Times, and Washington Post published articles the following day describing the decision. See Janus Capital Group v. First Derivative Traders, 131 S. Ct. 2296 (2011).Although newspaper coverage is not always associated with stock price movement, this apparent lack of attention in the newspapers to the Morrison decision is consistent with our finding ofstatistically insignificant returns to the stock portfolio. 37 The preliminary study submitted to the public comment file by Licht, Li, and Siegel (2011) found different results.

APPENDIX C


B13

We perform two checks to confirm that our results are not caused by the effects of returns that preceded the oral arguments. First, to eliminate the effect of the weekend and pre-market returns, we measure the abnormal return of the stocks using returns from the opening price to the closing price of each day. We find that the results were unaffected by this change. For instance, the abnormal return for Set #4 declined from 0.28% to 0.17%, and the t-statistic dropped from 0.27 to 0.21, but the results are substantially the same: a small abnormal return that is not close to statistical significance.

We also examine intraday transactions data from the New York Stock Exchange for indications of a reaction to the information released in the oral arguments. These charts do not provide any indication of a timely stock price drop in reaction to the news. Chart #2 provides the intraday chart for Set #4. The chart indicates that when markets opened on 3/29/2010, the cumulative return for the portfolio was higher than the previous close, and higher than the return for the market over the same time period. In addition, the cumulative return for the portfolio rose, relative to the market, between 10:30 a.m. and 11 a.m., prior to the start of the oral argument. Most importantly, the cumulative returns do not rise significantly between 11 a.m. and the close of trading. This pattern of cumulative returns during the day is inconsistent with a hypothesis that the oral arguments in Morrison had a statistically significant impact on the returns to this portfolio.

IV. Conclusion

Overall, the conflicting evidence in the academic literature and the results of our event study on the Morrison decision are inconclusive as to the net benefits or costs of a cross-borderextension of private rights of action.

APPENDIX C


B14

Tab

le 2

: E

vent

Stu

dy R

esul

ts:

Port

folio

Met

hod

and

Bro

wn-

War

ner

Met

hod

This

tabl

e pr

esen

ts re

gres

sion

resu

lts fr

om a

mar

ket m

odel

as w

ell a

s eve

nt st

udy

resu

lts fo

r the

dat

es o

f the

ora

l arg

umen

t and

the

publ

iciz

ed d

ecis

ion

in M

orri

son.

For

Set #

1, th

e po

rtfol

io o

f ret

urns

incl

udes

643

firm

s tha

t are

incl

uded

in th

e C

omm

issi

on’s

list

of I

nter

natio

nal R

egis

tere

d an

d R

epor

ting

Com

pani

es a

s of 1

2/31

/09,

afte

r el

imin

atin

g O

TC fi

rms.

Set

#2

adds

com

pani

es id

entif

ied

as in

corp

orat

ed o

utsi

de th

e U

nite

d St

ates

and

AD

Rs,

base

d on

dat

a fr

om th

e C

ente

r for

Res

earc

h in

Sec

uriti

es

Pric

es.

Set #

3 be

gins

with

Set

#1

and

rem

oves

com

pani

es th

at a

re n

ot li

sted

on

an e

xcha

nge

outs

ide

the

U.S

. Se

t #4

begi

ns w

ith S

et #

3, a

nd a

lso

excl

udes

com

pani

es

for w

hich

the

only

non

-U.S

. lis

ting

is in

Ger

man

y, a

nd th

e co

mpa

ny is

not

Ger

man

, bec

ause

man

y of

thes

e co

mpa

nies

hav

e lo

w tr

adin

g vo

lum

e in

Ger

man

y. P

anel

A

show

s the

resu

lts fo

r the

mar

ket m

odel

acr

oss t

he d

iffer

ent p

ortfo

lios.

The

por

tfolio

met

hod

and

the

Bro

wn-

War

ner m

etho

ds fo

r cal

cula

ting

abno

rmal

retu

rns,

alon

g w

ith c

orre

spon

ding

t-st

atis

tics,

are

pres

ente

d to

geth

er in

Pan

el B

for e

ach

data

set.

Set #

1Se

t #2

Set #

3Se

t #4

SEC

List

subj

ect t

o da

ta

avai

labi

lity,

ex

clud

ing

OT

C

Set #

1 pl

usco

mpa

nies

with

A

DR

s or

non-

U.S

. in

corp

orat

ion

Set #

1 ex

clud

ing

com

pani

es n

ot

liste

d ou

tsid

e U

.S.

Set #

3ex

clud

ing

com

pani

es w

ith lo

w

trad

ing

volu

me

outs

ide

the

U.S

.Pa

nel A

: Po

rtfo

lio R

egre

ssio

n R

esul

tsIn

terc

ept

0.00

1

0.

001

0.00

1 0.

001

t-sta

tistic

(1.7

6)(1

.83)

(1.8

5)(1

.79)

Bet

a (S

&P

500)

0.93

9

0.

965

0.95

9 0.

974

t-sta

tistic

(43.

38)

(47.

46)

(44.

71)

(44.

65)

R-s

quar

ed

0.

790

0.81

8

0.

800

0.79

9

Pane

l B:

Abn

orm

al R

etur

ns

Res

ults

-M

arch

29,

201

0Po

rtfo

lio

Met

hod

Bro

wn-

War

ner

Port

folio

M

etho

dB

row

n-W

arne

rPo

rtfo

lio

Met

hod

Bro

wn-

War

ner

Port

folio

M

etho

dB

row

n-W

arne

r R

aw re

turn

0.89

%0.

89%

0.89

%0.

90%

0.90

%0.

90%

0.92

%0.

92%

Abn

orm

al r

etur

n0.

28%

0.38

%0.

27%

0.37

%0.

27%

0.36

%0.

28%

0.35

%t-s

tatis

tic(0

.26)

-(0.

23)

(0.2

6)(0

.79)

(0.2

6)(0

.72)

(0.2

7)(0

.69)

Num

ber o

f obs

erva

tions

643

733

592

413

Res

ults

-Jun

e 24

, 201

0Po

rtfo

lio

Met

hod

Bro

wn-

War

ner

Port

folio

M

etho

dB

row

n-W

arne

rPo

rtfo

lio

Met

hod

Bro

wn-

War

ner

Port

folio

M

etho

dB

row

n-W

arne

rR

aw re

turn

-1.5

0%-1

.45%

-1.5

0%-1

.52%

-1.5

1%-1

.45%

-1.4

7%-1

.39%

Abn

orm

al r

etur

n0.

00%

0.07

%0.

00%

0.04

%0.

02%

0.10

%0.

08%

0.19

%t-s

tatis

tic-(

0.00

)(0

.15)

(0.0

0)(0

.10)

(0.0

2)(0

.19)

(0.0

8)(0

.37)

Num

ber o

f obs

erva

tions

634

722

587

408

APPENDIX C


B15

Tab

le 3

: C

ompa

riso

n M

arke

t Mod

el R

esul

ts:

Inte

rnat

iona

l Ind

ices

As a

poi

nt o

f com

paris

on fo

r the

resu

lts in

Tab

le 2

, thi

s tab

le p

rese

nts r

egre

ssio

n re

sults

from

a m

arke

t mod

el.

Inst

ead

of th

e co

nstru

cted

po

rtfol

ios o

f cro

ss-li

sted

firm

s tha

t wou

ld b

e ex

pect

ed to

be

affe

cted

by

the

Mor

riso

nde

cisi

on, t

hese

por

tfolio

s are

indi

ces o

f int

erna

tiona

l fir

ms,

man

y of

whi

ch w

ould

be

unaf

fect

ed b

y th

e M

orri

son

deci

sion

. Th

e re

sults

for b

oth

the

mar

ket m

odel

and

the

even

t stu

dies

are

si

mila

r to

the

resu

lts fo

r the

four

diff

eren

t tes

t por

tfolio

s pro

vide

d in

Tab

le 2

. Th

e t-s

tatis

tics a

re re

porte

d in

par

enth

eses

bel

ow th

e co

effic

ient

est

imat

es.

Van

guar

d T

otal

Wor

ld

Stoc

k In

dex

ET

F (V

T)

iSha

res

MSC

I EA

FE

Inde

x (E

FA)

iSha

res

MSC

I All

Cou

ntry

W

orld

Inde

x (A

CW

I)

Van

guar

d FT

SE A

ll-W

orld

ex-

US

Inde

x In

v (V

FWIX

)R

egre

ssio

n Pa

ram

eter

sIn

terc

ept

0.00

0 0.

000

0.00

00.

000

t-sta

tistic

(0.1

0)-(0

.17)

(0.0

2)-(

0.30

)B

eta

(S&

P 50

0)

1.

007

1.09

4

1.

003

1.

019

t-sta

tistic

(51.

47)

(61.

23)

(72.

78)

(59.

64)

R-s

quar

ed

0.

858

0.88

2

0.

914

0.

877

Num

ber o

f obs

erva

tions

440

503

503

503

APPENDIX C


B16

This chart shows the daily abnormal returns for Portfolio Set #4. It includes the companies identified as international registered and reporting firms by the SEC as of 12/31/2009, except that it: (a) excludes OTC companies, (b) includes only companies that are listed on a non-U.S. exchange, and (c) excludes non-German companies for the set of companies that are only listed in the U.S. and Germany. Each point on the chart is the abnormal return for each trading day between January 1, 2010 and December 31, 2010. The abnormal returns on the date of the oral arguments and the decision in Morrison are highlighted in red, and are shown as a square rather than a diamond.

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

1.50%

2.00%

4-Ja

n-10

4-Fe

b-10

7-M

ar-1

0

7-A

pr-1

0

8-M

ay-1

0

8-Ju

n-10

9-Ju

l-10

9-A

ug-1

0

9-Se

p-10

10-O

ct-1

0

10-N

ov-1

0

11-D

ec-1

0

Chart 1: Daily Abnormal Returns for Portfolio Set #4 1/1/2010 - 12/31/2010

Event Dates

APPENDIX C


Cha

rt 2

B17

APPENDIX C


B18

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APPENDIX C


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Foucault, Thierry and Laurent Fresard, 2011, Cross-Listing, Investment Sensitivity to Stock Price and The Learning Hypothesis, HEC Paris (working paper).

Foucault, Theirry and Thomas Gehrig, 2008, Stock Price Informativeness, Cross-Listings, and Investment Decisions, JOURNAL OF FINANCIAL ECONOMICS 88, 146-168.

Fox, Merritt B., 2011, Fraud-on-the Market Class Actions Against Foreign Issuers (working paper).

Fresard, Laurent and Carolina Salva, 2010, The Value of Excess Cash and Corporate Governance: Evidence from U.S. Cross-Listings, JOURNAL OF FINANCIAL ECONOMICS 98, 359-384.

Gagnon, Louis, and G. Andrew Karolyi and Louis Gagnon, 2011, The Economic Consequences of the U.S. Supreme Court’s Morrison v. National Australian Bank Decision for Foreign Stocks Cross-Listed in U.S. Markets (working paper).

Gande, Amar and Darius P. Miller, 2011, Why Do U.S. Securities Laws Matter to Non-U.S. Firms? Evidence from Private Class-Action Lawsuits (working paper).

Goldhaber, Michael, Out of Gas; During its four-year pursuit of Volkswagen, little Porsche outmaneuvered the giant carmaker—but then sputtered at the finish. Were Porsche's lawyers to blame?, AMERICAN LAWYER, May 1, 2010.

APPENDIX C


B20

Grinblatt, Mark and Sheridan Titman, 1998, FINANCIAL MARKETS AND CORPORATE STRATEGY,Irwin/McGraw Hill, New York, New York.

Hail, Luzi and Christian Leuz, 2009, Cost of Capital Effects and Changes in Growth Expectations Around U.S. Cross-Listings, JOURNAL OF FINANCIAL ECONOMICS 93, 428-454.

Halling, Michael, Marco Pagano, Otto Randl, and Josef Zechner, 2007, Where Is the Market? Evidence from Cross-Listings in the United States, REVIEW OF FINANCIAL STUDIES 21, 725-761.

Iliev, Peter, Darius P. Miller, and Lukas Roth, 2011, Uninvited U.S. Investors? Economic Consequences of Involuntary Cross-Listings (working paper).

Karolyi, G. Andrew and Louis Gagnon, 2010, Do International Cross-Listings Still Matter?” in Beck, Thorsten, Sergio Schmukler and Stijn Claessens, in EVIDENCE ON FINANCIAL

GLOBALIZATION AND CRISES.

Karolyi, G. Andrew, 2006, The World of Cross-Listings and Cross-Listings of the World: Challenging Conventional Wisdom, REVIEW OF FINANCE 10, 99-152.

Karolyi, G. Andrew, 2011, Corporate Governance, Agency Problems and International Cross-Listings: A Defense of the Bonding Hypothesis (working paper).

Lang, Mark H., Karl V. Lins, and Darius P. Miller, 2003, ADRs, Analysts, and Accuracy: Does Cross Listing in the United States Improve a Firm’s Information Environment and Increase Market Value?, JOURNAL OF ACCOUNTING RESEARCH 41, 317-345.

Lel, Ugur and Darius P. Miller, 2008, International Cross-Listing, Firm Performance, and Top Management Turnover: A Test of the Bonding Hypothesis, JOURNAL OF FINANCE 63, 1897-1937.

Leuz, Christian and Peter Wysocki, 2008, Economic Consequences of Financial Reporting and Disclosure Regulation: A Review and Suggestions for Future Research (working paper).

Licht, Amir N., Christopher Poliquin, Jordan I. Siegel, and Xi Li, 2011, What Makes the Bonding Stick? A Natural Experiment Involving the Supreme Court and Cross-Listed Firms, Harvard Business School (working paper).

MacKinlay, A. Craig, 1997, Event Studies in Economics and Finance, JOURNAL OF ECONOMIC

LITERATURE Vol. XXXV, 13-39.

Milev, Jordan, Robert Patton, and Svetlana Starykh, 2010, Trends 2010 Year-End Update: Securities Class Action Filings Accelerate in Second Half of 2010; Median Settlement Value atan All-Time High, NERA Economic Consulting.

Miller, Darius P., 1999, The Market Reaction to International Cross-Listings: Evidence from Depositary Receipts, JOURNAL OF FINANCIAL ECONOMICS 51, 103-123.

APPENDIX C


B21

Ross, Stephen A., Randolph W. Westerfield, and Jaffrey F. Jaffe, 2005, CORPORATE FINANCE,(7th ed.), McGraw-Hill Irwin, New York, New York.

Ryan, Ellen M. and Laura E. Simmons, 2011, Securities Class Action Settlements 2010 Review and Analysis, Cornerstone Research.

Sarkissian, Sergei and Michael J. Schill, 2011, The Nature of the Foreign Listing Premium: A Cross-Country Examination (working paper).

Sefcik, Stephan E. and Rex Thompson, 1986, An Approach to Statistical Inference in Cross-Sectional Models with Security Abnormal Returns as Dependent Variable, JOURNAL OF

ACCOUNTING RESEARCH, Vol. 24, No. 2, 316-334.

APPENDIX C


1

Defrauded Investors Deserve Their Day in Court

Dissenting Statement Regarding the Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934 as required by Section 929Y of the Dodd-Frank Wall Street Reform and Consumer Protection Act

By

Commissioner Luis A. Aguilar

Washington D.C.

April 11, 2012

Today the Commission has authorized that a Study expressing the views of the Staff be sent to Congress. However, my conscience compels me to write separately to record my views on the Study. I write to convey my strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank, Ltd.1 In the United States we have a strong belief that, whether rich or poor, we are all entitled to our day in court. Sadly, for many American investors this is no longer true.

If American investors are defrauded by a company that they have invested in – and that company is listed on a foreign exchange – investors may be unable to have their day in court and seek redress against this company for its lies and misrepresentations. Thus, investors have been stripped of a traditional American right.

This was not always the case. For decades, federal courts applied the same standard to determine whether U.S. federal securities law applied to frauds that took place, in whole or in part, outside of the United States. Under that standard, Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and other antifraud provisions applied “when there was „significant U.S. fraudulent conduct that directly caused the plaintiffs losses‟ (the conduct test) or when there were „significant effects‟ on the U.S. securities markets (the effects test).” 2 Under the conduct test, an investor could bring a Section 10(b) claim if a sufficient level of conduct comprising the fraud occurred in the United States, even if the victims or the purchases and sales were overseas. 3

Under the effects test, an investor could bring a Section 10(b) claim in a transnational securities fraud when the conduct occurring in foreign countries caused foreseeable and substantial harm to U.S. interests. 4

APPENDIX C


2

As a result of the conduct and effects test, if an American investor was lied to or defrauded in a securities transaction, that investor had the ability to have his or her day in court and seek legal recourse, even if the securities transaction was overseas.

However, this dramatically changed when, in Morrison, the Supreme Court severely restricted the extraterritorial scope of Section 10(b) of the Exchange Act. After Morrison, investors are restricted to bringing Section 10(b) claims related to frauds in connection with the “purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”5 As a result of Morrison, investors have been stripped of the ability to seek redress against those who have harmed them in a transnational securities fraud.

The United States Congress, realizing the danger, immediately responded to mitigate the Supreme Court‟s decision. The first step was to fully restore the ability of the Securities and Exchange Commission (“SEC” or “Commission”) and the Department of Justice (“DOJ”) to bring enforcement actions6 under Section 10(b) in cases involving transnational securities fraud pursuant to the pre-Morrison tests of conduct and effect.7 The second step was to request that the Commission conduct a Study on the Extraterritorial Scope of the Private Rights of Action under Section 10(b) of the Exchange Act (“Study”).8

Section 929Y of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires that the Commission‟s Study provide recommendations to Congress on whether private rights of action under the antifraud provisions of the Exchange Act should be extended to cover:

1. Conduct within the United States that constitutes a significant step in the furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; and

2. Conduct occurring outside the United States that has a foreseeable substantial effect within the United States.9

The Study falls far short of providing Congress with an informed recommendation and falls far short in fulfilling the Commission‟s mission to protect investors. I am particularly astonished that the Study states (at pages 58-59) that an option “would be for Congress to take no action” and, thus, would continue to deny American investors who have been harmed by fraud the ability to seek redress in court.

The evidence post-Morrison is stark and compelling. All of the predictions of the harm that the Morrison decision would inflict on investors have come to pass.10 It is clear that Morrison has deprived investors of their private rights of action under the Exchange Act with respect to a wide range of potentially fraudulent conduct that the United States has a compelling interest to regulate.

The answer to the Congressional query about whether to re-establish extraterritorial private rights of action under Section 10(b) of the Exchange Act through the application of the pre-Morrison tests of conduct and effect is an unequivocal yes.

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3

The Study is incomplete in many ways, but I will just highlight the following:

It Fails to Adequately Explain how Private Rights of Action are a Vital Complement to SEC Actions and Essential to Investor Protection;

It Overstates the International Comity Concerns Associated with Restoring Investors‟ Rights to Assert Private Claims Under Section 10(b);

It Does Not Accurately Portray Investor Harm Resulting from Morrison and Fails to Convey a Sense of Urgency as to the Harm Being Suffered; and

It Provides as an Option That Congress Take No Action at All Despite the Continuing Harm to Investors.

The Study should have recommended that Congress enact for private litigants a standard that is identical to the standard set forth in Section 929P of the Dodd-Frank Act – the standard for SEC and DOJ actions. The harm that has resulted and continues to result to investors is significant, and Congress should act to rectify this with haste. A Private Right of Action Is a Vital Complement to an SEC Action and Essential For Investor Protection The Study did not substantially address the importance of private rights of action as an essential tool for investor protection. The primary purpose of the Exchange Act is to “protect investors.”11 Given the explicit mandate provided in the Dodd-Frank Act to apply the U.S. securities laws to transnational frauds with strong connections to the United States,12 the purpose of the Exchange Act and the Commission‟s core mission to protect investors, it is clear that investors must have private rights of action co-extensive with the Commission‟s under Section 10(b). It is unrealistic to expect that the Commission will have the resources to police all securities frauds on its own, and as a result, it is essential that investors be given private rights of action to complement and complete the Commission‟s efforts.

Congress has long recognized the importance of a private action. In the Private Securities Litigation Reform Act of 1995, Congress reaffirmed that “[p]rivate securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers, and others properly perform their jobs.”13

The Supreme Court itself also “has long recognized that meritorious private actions to enforce federal antifraud securities laws are an essential supplement to criminal prosecutions and civil enforcement actions brought, respectively, by the Department of Justice and the Securities and Exchange Commission.”14 The Supreme Court has stated that this is especially true when it comes to actions under Section 10(b): “a private right of action under Section 10(b) of the [Exchange] Act and Rule 10b-5 has been consistently recognized for more than 35 years.”15

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4

Private litigation has historically played a complementary role to government enforcement in the Section 10(b) context, and to preclude private litigation, even where government actions are theoretically available, would lead to a material deficiency in the enforcement of Section 10(b). If one aspect of Section 10(b) enforcement (the protection of U.S. investors in connection with their non-U.S. securities transactions) is reserved solely to the SEC and DOJ, and private actions remain limited, a serious gap in the securities law framework is created. This gap strips investors of the right to seek accountability and redress directly when they have been harmed. The Study fails to adequately address the negative effects of the SEC‟s limited resources on investor protection in transnational securities fraud matters. By contrast, our senior management has publicly spoken about SEC actions being detrimentally impacted by budget constraints.16 The truth of the matter is that the SEC, does not, and will not, ever have enough resources to investigate all of the fraud cases that exist. The SEC will never be able to seek justice in all of the potential transnational securities fraud matters. Thus, the SEC will not be able to seek redress for all investors who are harmed by those who violate the securities laws. Knowing this, we should support providing investors with the ability to protect themselves. In fact, even if the SEC exercises its discretion to bring a case, rarely are investors made whole. Quite often, investors receive only pennies on the dollars for their losses.17 Moreover, issuers, aware of the SEC‟s inability to pursue all fraud, will not be incentivized to obey the law when they know that investors are barred from seeking accountability for wrongdoing. Private litigation provides investors the opportunity to seek redress against those who harmed them.18 In light of the limited resources available to the SEC, private enforcement of the federal securities laws is a necessary tool to combat securities fraud. The current Morrison prohibition of private litigation where government actions are permitted is resulting in harm to investors now.19 Historically, the Commission has consistently advocated private rights of action precisely because they are a vital complement to the Commission‟s enforcement program in deterring misconduct.20 Investors who have been harmed must have the ability to seek redress. I believe that private litigation is critical to investor protection, especially in light of the Commission‟s limited resources.

The Study Overstates the International Comity Concerns Associated with Restoring Investors’ Rights to Assert Private Claims under Section 10(b) The Study provides that the enactment of the “Commission and DOJ conduct and effects tests for Section 10(b) private actions would involve policy trade-offs that could carry significant implications in many areas, including … international comity.”21 The Study states that “[i]nternational comity is frequently implicated in the context of transnational securities fraud, particularly given that issuers and investors may be located in multiple jurisdictions and various parts of their securities transactions may occur in each of these jurisdictions.”22 However, the Study did not provide a single instance where private securities fraud litigation has actually

APPENDIX C


5

interfered with a non-U.S. sovereign‟s ability to independently regulate its own securities market. I do not believe that international comity should prevent investors from seeking to assert private claims under Section 10(b). The doctrine of international comity is implicated only when there is a true conflict between American law and the law of a foreign jurisdiction.23 The Supreme Court has found that there is no conflict for purposes of comity “where a person subject to regulation by two states can comply with the laws of both.”24 In determining whether comity is implicated, courts will look to whether the respective laws or policies contradict one another, not to whether one set is stronger or more effective in achieving similar objectives.25 While I recognize that foreign nations have a significant interest in determining the legal remedies their own residents should receive, I believe the United States has a legitimate interest in making that determination for its citizens in the context of transnational securities, regardless of where the actual securities transaction occurred. I agree with the 42 law professors who signed a comment letter stating that international “comity does not require that the U.S. tolerate or protect fraudulent conduct that emanates from or has significant effects within its borders.”26 I believe it is also important to point out that international comity was not undermined by the application of the conduct and effects test in the 40 years of transnational securities fraud cases preceding Morrison. 27 In fact, comity concerns argue in favor of permitting even foreign fraud victims a remedy under the U.S. securities laws, to the extent they were damaged by conduct in the United States, even if the fraud relates to a security purchased on a foreign exchange. Failure to accord such a remedy would allow the United States to be a platform for fraud and leave some fraud victims with no recourse in any jurisdiction. As Judge Friendly noted:

This country would surely look askance if one of our neighbors stood by silently and permitted misrepresented securities to be poured into the United States.28

The conduct and effects test was designed, in part, to prevent the U.S. from being used as a launching pad for the exporting of fraud. Allowing investors the ability to bring a transnational fraud claim within the parameters of the conduct and effects test would, in fact, enhance international comity by promoting a global marketplace in which investors are protected. Restoring Private Litigants’ Ability to Bring Transnational Fraud Claims Would Not Result In a Flood of Litigation in U.S. Courts The Study failed to adequately discuss the evidence illustrating that restoring private litigants‟ ability to bring transnational fraud claims would not result in a flood of litigation involving foreign issuers in U.S. courts. Section 929P itself includes limits that preclude the prosecution of Section 10(b) claims that have an insignificant connection to the U.S.29 Accordingly, cases without sufficient material ties to the U.S. – whether in the context of significant conduct in the U.S. or a significant effect on U.S. investors – would not be prosecuted in its courts.30

APPENDIX C


6

In addition, the number of securities class actions against foreign issuers has historically been a small fraction of the number of securities fraud cases litigated under the U.S. federal securities laws. From 1996 through 2009, on average, only 9.7% of securities actions filed were against foreign issuers.31 Moreover, only 11% of the securities actions filed through the third quarter of 2010 (i.e., prior and subsequent to the Morrison decision in June 2010) were against companies domiciled in a foreign country.32 Of the over 530 suits settled in 2009, only approximately 50 of them were against defendants domiciled in a country outside the U.S.33 Statistical data indicates that restoring U.S. investors‟ ability to bring transnational fraud claims would not result in a flood of litigation in U.S. courts. The Study also fails to adequately discuss the fact that many meritorious litigation claims involving thousands upon thousands of investors are now no longer being brought. Under Morrison, for example, cases such as In re Tyco International Ltd.,34 would have been dismissed. In this matter, Tyco International Ltd. (“Tyco”) misrepresented the value of several different companies Tyco acquired and misreported its financial condition. U.S. investors received, in part, $3.2 billion in monetary relief as a result of this private litigation. 35 After Morrison, Tyco investors may not have had their day in court. Thus, not only is there not a flood of litigation – there is now a severe curtailment of the ability of investors to seek redress as to fraudulent activity. Morrison Weakens the Federal Securities Laws and Strips Investor Protections The Study also did not adequately focus on how Morrison has harmed investors by weakening the federal securities laws and stripping investor protections. Under Morrison, the private right of action only reaches the purchase or sale of a security listed on an American stock exchange, or other domestic transactions.36 However, determining whether a transaction occurred domestically can prove difficult, and can result in anomalous results for investors worldwide. Under Morrison, as applied, a private plaintiff trading outside the U.S. may not be able to recover for fraud “even if the securities at issue were registered and listed on a U.S. exchange unless it also can establish that the particular shares it traded were registered and listed on a U.S. exchange.”37 But in today‟s global economy, many investors may not know where purchase orders for particular securities are actually carried out. As commentators have noted, “markets are moving to a point where the site of a trade is happenstance.”38 Investors cannot be certain when they place an order to purchase or sell securities – even those listed on a U.S. exchange – that their brokers will not use a foreign exchange to execute the order. Many securities are often listed on at least two exchanges – one foreign and one domestic. In fact, such household names as GE, IBM, Pfizer, and Bank of America are traded on multiple domestic and foreign exchanges.39 As a result, depending on how these shares were purchased, holders of these securities may not have private rights of action, should fraud occur at these companies. The Morrison test fails to recognize the realities of today‟s modern global trading environment, and it punishes investors who often do not know whether their respective securities transactions were ultimately executed on a U.S or foreign exchange.40

APPENDIX C


7

As Justice Stevens‟ concurrence in Morrison points out, the current Morrison test for private rights of action is also at odds with the primary purpose of the Exchange Act: to protect the interests of investors.41 Morrison and its recent progeny increasingly are making it clear that the anti-fraud protections of the Exchange Act will not be extended to those U.S. investors who purchase securities listed on non-U.S. exchanges, regardless of the extent of the fraudulent conduct that took place in the United States, or the effect of the effect of fraudulent conduct on the United States or on U.S. citizens.42 U.S. investors have been deprived rights to sue, even though the fraud is perpetuated upon them within the United States. The inability of investors to hold those responsible for committing fraud within the U.S. accountable for their actions leaves investors harmed and weakens confidence in the market as a whole.

In sum, the Morrison test disadvantages investors and is at odds with the very purpose of the securities laws.

The Study Did Not Adequately Address the Lack of Available Remedies Outside of the United States

The Study also did not adequately detail the lack of remedies available to investors if private rights of action were precluded for transnational securities fraud. Although remedies for U.S. investors are theoretically available outside of the United States, in reality, a number of hurdles exists – such as the need for U.S. investors to retain foreign counsel, the uncertainty about laws governing investors‟ rights (including whether U.S. residents are even protected by foreign law), the lack of a developed class action mechanism, and the lack of contingency fee litigation. These are obstacles that effectively preclude a majority of U.S. investors from pursuing any relief for injuries suffered from securities purchased outside of the United States.43

The danger investors‟ face is real. The practical reality is that investors have been stripped of certain legal remedies to address fraudulent activity that may occur in connection with their securities transactions. Given this new harsh and tragic reality, it is only rational that the staff should issue a study that actually advocates for investors by recommending a clear direction that would enhance investor protection – and that supports over four decades of federal court jurisprudence that provided investors access to the federal securities laws in order to protect against fraud arising from purchased securities, even if purchased on foreign markets. Unfortunately, the staff has failed investors by shirking this basic obligation.

Conclusion

As I have stated above, Morrison and its recent progeny increasingly are making it clear that the anti-fraud protections of the Exchange Act will not be restored to those U.S. investors who purchase securities listed on non-U.S. exchanges, regardless of the extent of the fraudulent conduct in which foreign companies engage in the United States, or the effect of such conduct in the United States or on U.S. citizens.

APPENDIX C


8

Investor protection is at the core of the SEC‟s mission; supporting all of its other responsibilities. Properly functioning financial markets require the protection of investors‟ rights. U.S. investors expect to be protected by U.S. securities laws, regardless of where the securities transaction ultimately occurs. It is my view that investors should have a private right of action under the antifraud provisions of the Exchange Act in transnational securities fraud cases, in accordance with the conduct and effects test. This would be consistent with the authority granted by Congress to the SEC and DOJ, as has been the case for 40 years prior to the Morrison decision.

1 130 S. Ct. 2869 (2010). 2Linda J. Silberman, Morrison v. National Australia Bank: Implications for Global Securities Class Actions, New York University School of Law, Public Law & Legal Theory Research Paper Series, Working Paper No. 11-41 (June 2011). See, e.g. Alfadda v. Fenn, 935 F. 2d 475, 478 (2d. Cir. 1991), Itoba Ltd. v. LEP Group PLC, 54 F.3d 121-22 (2d Cir. 1995). Courts also applied an admixture of the two tests. See generally, Dennis R. Dumas, United States Antifraud Jurisdiction Over Transnational Securities Transactions: Merger of the Conduct and Effects Tests, 16 U. PA. J. Int‟l Bus. L. 721 (1995). 3Psimenos v. E.F. Hutton & Co., 722 F.2d 1041, 1045 (2d Cir. 1983), S.A. v. Banque Paribas London, 147 F.3d 118, 125 (2d Cir. 1998). 4Mak v. Womcom Commodities Ltd., 112 F.3d 287, 289 (7th Cir. 1997) (quoting Tamari v. Bache & Co. (Lebanon) S.A.L., 730 F.2d 1103, 1108 (7th Cir. 1984)). See also, Banque Paribas London, 147 F.3d at 125; S.A. v. Edperbrascan Corp., 23 F. Supp. 2d 425, 430 (S.D.N.Y. 1998). 5Supra Note 1 at 2888. See also, Morrison, 130 S. Ct. at 2884 (“[I[t is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which § 10(b) applies.”). 6With respect to Commission and DOJ actions under Section 10(b), Dodd-Frank Act Section 929P(b) codified, the pre-Morrison view that the extraterritoriality inquiry is one of subject matter jurisdiction by adding the following provision to Section 27 of the Exchange Act:

(b) EXTRATERRITORIAL JURISDICTION. – The district courts of the United States and the United States courts of any Territory shall have jurisdiction of an action or proceeding brought or instituted by the Commission or the United States alleging a violation of the antifraud provisions of this title involving –

(1) conduct within the United States that constitutes significant steps in furtherance of

the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or


7Section 929P of the Dodd-Frank Act was intended to negate the harmful effects of the Morrison decision and to protect investors affected by transnational frauds by codifying the authority to bring proceedings under the conduct and the effects tests developed by the federal courts regardless of the jurisdiction of the proceedings. Cong. Record, June 30, 2010, p. H5237, available at http://www.gpo.gov/fdsys/pkg/CREC-2010-06-30/html/CREC-2010-06-30-pt1-PgH5233.htm. 8As required by Section 929Y of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

APPENDIX C


9

9Supra Note 6. 10See, e.g., In re Royal Bank of Scotland Grp. PLC Sec. Litig., No. 09 Civ. 300 (DAB), 2011 WL 167749 (S.D.N.Y. Jan. 11, 2011); Plumbers’ Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., No. 08 Civ. 1958 (JGK), 2010 WL 3860397; In re Alstom SA Securities Litigation, No. 03 Civ. 6595 (VM), 2010 WL 3718863 (S.D.N.Y. 2010); In re Societe Generale Sec. Litig., No. 08 Civ. 2495 (RMB), 2010 WL 3910286 (S.D.N.Y. Sep. 29, 2010); Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620 (S.D.N.Y. 2010); In re Banco Santander Securities – Optimal Litig., 732 F. Supp. 2d 1305 (S.D. Fla. 2010); and Terra Secs. ASA Konkursbo v. Citigroup, Inc., No. 09 Civ. 7058 (VM), (S.D.N.Y. Aug. 16, 2010) 11See, Morrison, 130 S. Ct. at 2894 (“it is the „public interest‟ and „interest of investors‟ that are the objects of the statute‟s solicitude”) (Stevens, J., concurring). 12Supra note 6. 13Securities Litigation Reform Act, Conference Report, H.R. 104-369, 104th Cong., 1st Sess. (Nov. 28, 1995), available at http://www.gpo.gov/fdsys/pkg/CRPT-104hrpt369/pdf/CRPT-104hrpt369.pdf. 14Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 28, 313 (2007); J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964) (private rights of action under the securities laws are a “necessary supplement to Commission action.”). 15Herman & McLean v. Huddleston, 459 U.S. 375, 380 (1983). 16Testimony on Budget and Management of the U.S. Securities and Exchange Commission by Robert Khuzami, Division of Enforcement, Meredith Cross, Director, Division of Corporation Finance, Robert Cook, Director, Division of Trading and Markets, Carlo di Florio, Director, Office of Compliance Inspections and Examinations, Eileen Rominger, Director, Division of Investment Management, Before the United State House of Representatives Committee on Financial Services, Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises, (March 10, 2011), available at http://sec.gov/news/testimony/2011/ts031011directors.htm. Testimony on the President‟s FY 2012 Budget Request for the SEC by Chairman Mary Schapiro, Before the United States Senate Subcommittee on Financial Services and General Government, Committee on Appropriations (May 4, 2011), available at http://sec.gov/news/testimony/2011/ts050411mls.htm. 17Although the SEC recovered $140 million for investors defrauded by Enron, investors recovered more than $7 billion in private suits. See, Thomas C. Pearson, Enron’s Bank s Escape Liability (2010), available at http://www.bus.lsu.edu/accounting/faculty/lcrumbley/jfia/Articles/FullText/2010v2n1a5.pdf. 18See, e.g., Itoba Ltd. v. LEP Group PLC, 54 F.3d 118 (2d Cir. 1995); In re DaimlerChrysler AG Sec. Litig., Case No. 00-993 (D. Del.); and In re Nortel Networks Corp. Sec. Litig., 238 F. Supp. 2d. 613 (S.D.N.Y. 2003).. 19Supra note 10. 20With respect to implied rights under Section 10(b) and Rule 10b-5, the Commission filed amicus briefs in Matheson v. Armburst, 284 F.2d 670 (9th Cir. 1960), cert. denied, 365 U.S. 870 (1961) (opposition to petition for certiorari only); Hooper v. Mountain States Sec. Corp., 282 F.2d 195 (5th Cir. 1960), cert. denied, 365 U.S. 814 (1961); Errion v. Connell, 236 F.2d 447, 454 (9th Cir. 1956); Fratt v. Robinson, 203 F.2d 627, 628 (9th Cir. 1953); Slavin v. Germantown Fire Ins. Co., 174 F.2d 799, 800 (3d Cir. 1949); Herman & MacLean v. Huddleston, 459 U.S. 375 (1983); and Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975). 21Study by the Staff of the U.S. Securities and Exchange Commission: “Study on the Extraterritorial Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934” at 60 (March 2012). 22Id. at 10. 23Hartford Fire Ins. Co v. California, 509 U.S. 764, 798 (1993).

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24Id. (citing, Restatement (Third Foreign Relations Law, Section 403)). 25In re South African Apartheid Litig., 617 F. Supp. 2d 228, 283 (S.D.N.Y. 2009). 26Comments by Forty-Two Law Professors, SEC File No. 4-617 (February 18, 2011), available at http://www.sec.gov/comments/4-617/4617-28.pdf. 27See, e.g., Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir. 1991); Grunenthal GmbH v. Hotz, 712 F.2d 421, 425 (9th Cir. 1983); Continental Grain (Australia) Pty. Ltd. v. Pacific Oilseeds, Inc., 592 F.2d 409, 421 (8th Cir. 1979); SEC v. Kasser, 548 F.2d 109 (3d Cir. 1977); Mak v. Wocom Commodities Ltd., 112 F.3d 287, 289 (7th Cir. 1997) (quoting Tamari v. Bache & Co. (Lebanon) S.A.L., 730 F.2d 1103, 1108 (7th Cir. 1984)). See also, Banque Paribas London, 147 F.3d at 125. See also, Interbrew S.A. v. Edperbrascan Corp., 23 F. Supp. 2d 425, 430 (S.D.N.Y. 1998). In re Parmalat Sec. Litig 375 F. Supp. 2d 278 (S.D.N.Y. 2004); In re Tyco International Ltd. 535 F. Supp. 2d 249 (D.N.H. 2007); In re Nortel Networks Sec. Litig 238 F. Supp. 2d. 613 (S.D.N.Y. 2003); and In re Deutsche Telekom AG Sec. Litig F. Supp 2d 277 (S.D.N.Y. 2007). According to a group of sixty-nine institutional investors from outside of the United States (with over 2 trillion U.S. dollars in assets under management) restoring investors‟ rights to assert private claims under Section 10(b) to the extent the Commission or DOJ is permitted will not undermine international comity. See, February 18, 2011 Letter from AGEST Superannuation Fund; Alecta pensionsförsäkring, ömsesidigt; AMF Fonder AB; AMF Pensionsförsäkring AB; APG Algemene Pensioen Groep N.V.; ASSETSuper Superannuation Fund; ATP - Arbejdsmarkedets Tillægspension; AUST (Q) Superannuation Fund; Australian Catholic Superannuation & Retirement Fund; Australian Institute of Superannuation Trustees; Australian Reward Investment Alliance; Australian Superannuation Fund; Australia‟s Unclaimed Super Fund; AustSafe Superannuation Fund; AVSuper Superannuation Fund; Catholic Superannuation Fund; Construction & Building Industry Superannuation Fund; Danica Pension; Danske Invest Management A/S; Electricity Supply Industry Superannuation Fund; Emergency Services & State Superannuation Fund; Energy Industries Superannuation Scheme; FIL Investments International; FirstSuper Superannuation Fund; Folksam; Forsta AP-Founden; GMB Trade Union; Health Employees Superannuation Trust Australia; Health Superannuation Fund; HOSTPLUS Superannuation Fund; Industriens Pension; KLP Kapitalforvaltning; Labour Union Co-operative Retirement Fund; Legalsuper Superannuation Fund; Local Government Superannuation Scheme; Local Super (SA-NT) Superannuation Fund; Maritime Superannuation Fund; Media Superannuation Fund; Merseyside Pension Fund; Motor Trades Association of Australia Superannuation Fund; Non-Government Schools Superannuation Fund; Nordea Fondbolag Finland AB; Nordea Fondene Norge AS; Nordea Fonder AB; Nordea Investment Funds Company I S.A.; OMERS Administration Corporation; PFA Pension; PGGM Vermogensbeheer B.V. (PGGM Investments); Raiffiesien Capital Management; Retail Employees Superannuation Trust; Royal Mail Pension Plan; Sampension KP Livsforsikring A/S; SKAGEN A/S; Skandinaviska Enskilda Banken AB; SPEC Superannuation Fund; State Superannuation Scheme // SAS Trustee Corporation; Statewide Superannuation Fund; Sunsuper Superannuation Fund; Swedbank Robur Fonder AB; Syntrus Achmea; Tasplan Superannuation Fund; Telstra Superannuation Fund; The Australian Council of Superannuation Investors; TWUSUPER Superannuation Fund; UniSuper Superannuation Fund; Universities Superannuation Scheme; Varma Mutual Pension Insurance Company; VicSuper Superannuation Fund; and VisionSuper Superannuation Fund (AGEST, et al.”), available at http://www.sec.gov/comments/4-617/4617-42.pdf. 28IIT v. Vencap, Ltd., 519 F.2d 1001, 1017 (2d Cir. 1975). 29Dodd-Frank Act Section 929P(b) requires “conduct within the United States that constitutes significant steps in furtherance of the violation, even if the violation is committed by a foreign adviser and involves only foreign investors; or conduct occurring outside the United States that has a foreseeable substantial effect within the United States.” 30U.S courts often have sustained defense motions for dismissal for lack of subject matter jurisdiction over foreign investors under Fed. R. Civ. P. 12 (b) (l) and, in class actions, at the class certification stage. In addition to these grounds, where a defendant has successfully shown that an adequate forum is available elsewhere, and that the private and public interests implicated in the case weighs strongly in favor of dismissal or removal to another forum

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courts have also dismissed actions under forum non conveniens. See, Sinochem Int’l Co. Ltd. v. Malaysia Int’l Shipping Corp., 504 U.S. 422, 436 (2007). 31See, Cornerstone Research, Securities Class Action Filings – 2010 Year in Review (2011). 32 See, Advisen Quarterly Report – Q3 2010, at 11-12. 33 See, Risk Metrics Blog, “Morrison v. National Australia Bank – the Dawn of a New Age” (June 25, 2010), available at http://blog.issgovernance.com/slw/2010/06/morrison-v-national-australia-bank---the-dawn-of-a-new-age.html. 34 535 F. Supp. 2d 249 (D.N.H. 2007) 35In re Tyco International Ltd. 535 F. Supp. 2d 249 (D.N.H. 2007) – The plaintiffs (the lead plaintiffs were several U.S. pension funds) also alleged that the individual defendants looted the company by misappropriating corporate funds in the form of undisclosed cash bonuses and forgiven loans. The proceeds were then used to reward the individual defendants for their participation in the accounting fraud scheme. The plaintiffs argued that this looting and accounting fraud scheme defrauded the investing public in violation of the federal securities laws. The plaintiffs also claimed that the defendants made materially false and misleading statements and omitted material information in various registration statements and publications, which concealed the corporate misconduct and mismanagement. Other example of pre-Morrison cases that would have been dismissed under Morrison include: In re Deutsche Telekom AG Sec. Litig. F. Supp. 2d 277 (SDNY 2002) – In this matter the prospectus and registration statement issued in connection Deutsche Telekom‟s IPO were alleged to be materially false and misleading on the grounds that the documents (1) failed to disclose that Deutsche Telecom was at that time engaged in advanced merger talks with VoiceStream Wireless Corp., and (2) overstated Deutsche Telekom‟s real estate portfolio by at least $1.8 billion dollars. U.S investors received in part $120 million in monetary relief as a result of this litigation. In re Nortel Networks Sec. Litig 238 F. Supp. 2d. 613 (2003 SDNY) – In this matter Nortel issued false and misleading press releases about its financial strength and projected growth. U.S. investors received in part $1.14 billion in monetary relief as a result of this litigation. In re Parmalat Sec. Litig. 375 F. Supp. 2d 278 (2004 SDNY) – In this matter Parmalat allegedly underreported its debts by nearly $10 billion and over-reported its net assets by $16.4 billion. The complaint alleged that insiders at Parmalat created a scheme involving misleading transactions and off-shore entities that created the appearance of financial health. U.S. investors received in part $86.8 million in monetary relief as a result of this litigation. In re Royal Ahold N.V. Sec. Litig 351 F. Supp. 2d 334 (2004 Dist MD) – In this matter accounting irregularities and discrepancies were discovered, which stemmed mainly from two company practices: (1) the company inflated the reporting of its income from vendor rebates or promotional allowances by its subsidiary USF; and (2) the company improperly attributed its revenues from joint ventures in which it did not have a controlling stake. As a result, on May 8, 2003 the company announced an $885 million restatement. U.S. investors received in part $1.1 billion in monetary relief as a result of this litigation. 36130 S. Ct. at 2888 (“Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”). 37Supra Note 26 at page 13. 38Supra Note 26 at page 7. 39 See, General Electric Co. Investor Relations available at http://www.ge.com/investors/personal_investing/index.html; International Business Machines Investor Relations available at http://www.ibm.com/investor/faq/item/stock-exchanges.wss; Pfizer Inc Investor Relations available at http://www.pfizer.com/investors/shareholder_services/shareholder_faqs.jsp; and Bank of America Investor Relations available at http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-contact

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40See, e.g., letters from AGEST, et al, available at http://www.sec.gov/comments/4-617/4617-42.pdf; CalPERS, available at http://www.sec.gov/comments/4-617/4617-43.pdf; National Association of Shareholder and Consumer Attorneys (“NASCAT”), available at http://www.sec.gov/comments/4-617/4617-18.pdf; Leandro Perucchi, available at http://www.sec.gov/comments/4-617/4617-40.pdf; California State Teachers‟ Retirement System (CalSTRS), Colorado Public Employees‟ Retirement System, Delaware Public Employees‟ Retirement System, State Board of Administration of Florida, North Carolina Department of State Treasurer, Connecticut Treasurer‟s Office, Maryland State Retirement and Pension System, Pennsylvania Public School Employees‟ Retirement System, Rhode Island General Treasurer, Pennsylvania State Employees‟ Retirement System, New York City Employees‟ Retirement System, New York City Police Pension Fund, Teachers‟ Retirement System of the City of New York, New York Fire Department Pension Fund, Board of Education Retirement System of the City of New York, Pension Reserves Investment Management Board Commonwealth of Massachusetts (“CalSTRS, et al.”), available at http://www.sec.gov/comments/4-617/4617-13.pdf.

41See, Morrison, 130 S. Ct. at 2894 42See, e.g., In re Royal Bank of Scotland Grp. PLC Sec. Litig., No. 09 Civ. 300 (DAB), 2011 WL 167749 (S.D.N.Y. Jan. 11, 2011); Plumbers’ Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., No. 08 Civ. 1958 (JGK), 2010 WL 3860397; In re Alstom SA Securities Litigation, No. 03 Civ. 6595 (VM), 2010 WL 3718863 (S.D.N.Y. 2010); In re Societe Generale Sec. Litig., No. 08 Civ. 2495 (RMB), 2010 WL 3910286 (S.D.N.Y. Sep. 29, 2010); Cornwell v. Credit Suisse Group, 729 F. Supp. 2d 620 (S.D.N.Y. 2010); In re Banco Santander Securities – Optimal Litig., 732 F. Supp. 2d 1305 (S.D. Fla. 2010); and Terra Secs. ASA Konkursbo v. Citigroup, Inc., No. 09 Civ. 7058 (VM), (S.D.N.Y. Aug. 16, 2010) 43See, John W. Moka III, et al., 2010 a Record Year for Securities Litigation – An Advisen Quarterly Report – 2010 Review, Advisen (Only “[t]hree percent of [securities suits] were filed in courts outside the United States”), available at https://www.advisen.com/downloads/sec_lit_Q42010_report.pdf. See also, e.g., Johnathan Stempel and Sinead Cruise “Olympus investors may find courthouse door closed” Thomson Reuters (November 9, 2011), available at http://newsandinsight.thomsonreuters.com/Legal/News/2011/11_-_November/Analysis__Olympus_investors_may_find_courthouse_door_closed/.