Absolute Activist Value Master Fund Ltd. v. Ficeto: Defining “Domestic” Security

In Absolute Activist Value Master Fund Ltd. v. Ficeto, No. 11-0221-CV, 2012 WL 661771 (2d Cir. Mar. 1, 2012), the appeals court reversed the dismissal of foreign hedge funds’ complaint for lack of subject matter jurisdiction and affirmed the dismissal for failure to state a claim, granting leave to amend.

Nine Cayman Islands hedge funds (the “Funds” or “Plaintiffs”) alleged fraud under §10(b) of the Securities Exchange Act, 15 U.S.C. §78j(b), and Rule 10b-5, 17 C.F.R. §240.10b-5. Plaintiffs also alleged various common law fraud claims.

The Funds sought relief against Absolute Capital Management Holdings Limited (“ACM”), several entities controlled by ACM, and individuals associated with ACM (collectively “Defendants”). Defendants allegedly engaged in a “pump-and-dump” scheme by purchasing billions of shares directly from U.S. companies on behalf of the Funds. Defendants purportedly traded and retraded these shares, frequently between the Funds, to artificially inflate stock price and increase trade volume. The U.S. companies allegedly gave Defendants shares in exchange for the Funds purchasing the shares at issue in the complaint. The purpose was to generate high commissions and to enable Defendants to sell their stock in the U.S. companies to the Funds at a windfall. Plaintiffs claimed damages in the amount of $195,916,216.

The Second Circuit analyzed “under what circumstances the purchase or sale of a security that is not listed on a domestic exchange should be considered ‘domestic.’” Section 10(b) applies only to domestic purchases or sales. See Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). A purchase or sale of a security “is the act of entering into a binding contract to purchase or sell securities,” and it occurs when the parties become bound to the transaction. Irrevocable liability is incurred at the moment the transaction occurs. Because irrevocable liability is used to determine the timing of a securities transaction, the court reasoned this test also determined the location of a securities transaction. Another method applied to determine location was the ordinary definition of “sale,” which is “the transfer of property or title for a price.” Accordingly, a sale “can be understood to take place at the location in which title is transferred.”

The Funds argued that because the transactions did not involve a foreign exchange and were direct sales by U.S. companies, a domestic transaction existed. However, the court found that the complaint had been drafted before the Supreme Court’s decision in Morrison and, as a result, only a few of the allegations in the complaint mentioned the location of the transactions, and did so in merely a conclusory fashion. The allegations in the complaint that did refer to locations were meant to satisfy the conduct and effects test that had been overturned in Morrison. The court held that Plaintiffs failed to state a claim under the new standard but remanded with instructions to give Plaintiffs leave to amend their complaint to comply with the new standard.

The primary materials for this case may be found on the DU Corporate Governance website.

Kirstin Dvorchak