We are discussing CITY OF PONTIAC POLICEMEN’S AND FIREMEN’S RETIREMENT SYSTEM v. UBS, a decision holding that Rule 10b-5 does not apply to transactions involving securities listed on a domestic stock exchange that are co-listed on a foreign exchange, at least where the transactions occurred outside the United States.
The reasoning conflicts with the analysis in Morrison. Morrsion, for better or worse, set out two circumstances where investors could state a claim using Rule 10b-5. The first was based upon the type of security. Investors could bring actions involving securities listed on a domestic stock exchange. The second was a transactional test. Investors could bring actions where the transaction occurred in the U.S.
In City of Pontiac, the court made the transactional test the exclusive method of stating a claim under Rule 10b-5. In effect, sales invovling listed shares could only give rise to an action under Rule 10b-5 if they in fact occurred in the United States. See Id. (finding that Rule 10b-5 did not apply to "claims by a foreign purchaser of foreign‐issued shares on a foreign exchange simply because those shares are also listed on a domestic exchange.").
The court got there by asserting that the "listing theory" was simply a "proxy for a domestic transaction." Perhaps. But because the Supreme Court explicitly held that Rule 10b-5 applied to "domestic transactions in other securities," the "proxy" could only have meaning if it did something additional. The "proxy" was effectively an over-inclusive test that allowed for actions involving shares of listed companies no matter where the transactions occurred. Moreover, it was a "proxy" explicitly imposed by Congress and included in the language of Section 10(b). See 15 USC 78j(b) (provision applies to deceptive conduct “in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.”).
The court tried to divine some additional support for its position mostly from silence on the part of the majority in Morrison. The shares at issue in Morrison were listed in Australia and listed in the U.S. in the form of ADRs and this, according to the court, "did not affect the Court’s analysis of the shares that were purchased on foreign exchanges." True, but this was because Morrison involved two different securities: shares in the bank and ADRs. The ADRs were listed in the U.S. But as note 1 in Morrison points out, none of the remaining plaintiffs in the case had alleged that they purchased ADRs (Ironically it was Morrison himself who had purchased ADRs but his claims were dismissed and not part of the case). Thus, Morrison did not involve the overseas purchase of a security listed on a domestic exchange.
Finally, the court in the City of Pontiac emphasized that Morrison had "rejected our prior holding that 'the Exchange Act [applies] to transactions regarding stocks traded in the United States which are effected outside the United States . . . .’ ” But Morrison did so in a context where the Second Circuit relied not on the type of security involved but on the possible effects of the transaction. Morrison merely rejected the test. The decision did not address or even remotely speak to whether a case decided under the effects test could nonetheless support the use of Rule 10b-5 under a different theory.
So what is going on here? The Second Circuit is uncomfortable with a test that allows the use of Rule 10b-5 in cases that have limited nexus to the U.S. Most of the plaintiffs in City of Pontiac were foreign. All of the transactions apparently occurred outside the United States. And the securities were listed on foreign exchanges.
But this was a direct consequence of the reasoning in Morrison. Morrison rendered irrelevant the location of the harm, the foreign nature of the security, or the identity of the investors. Instead, the Court substituted a bright line test that looked only to whether the security was listed on a domestic exchange or the transaction closed in the U.S. The shares in City of Pontiac were, in fact, listed on the NYSE.
As we have noted before, the type of analysis used in City of Pontiac is really a reverse effects test. Courts are apparently willing to follow the Supreme Court and reject cases that have great effect in the U.S. but otherwise do not involve listed securities or trades that occurred in the U.S. At the same time, however, the courts appear to want to reinstate the effects test where the cases brought under the Morrison standard appear to have little effect in the U.S. But that is not a determination for the lower courts to make. The Supreme Court has decreed that the effects don't matter. In this case, the shares at issue were listed on a domestic exchange. That fact alone is sufficient to permit the use of Rule 10b-5.