In re Optimal U.S. Litigation: Presumption against Extraterritoriality of Exchange Act Trumps Plaintiffs’ Claims in Madoff Feeder Case

In In re Optimal U.S. Litigation, 10-cv-04095-SAS, 2012 WL 1988713 (S.D.N.Y. June 4, 2012), the district court dismissed the plaintiffs’ securities claims, holding that, under Morrison, the Securities Exchange Act of 1934 (“Exchange Act”) did not reach those claims.

The plaintiffs were investors in Optimal U.S., an investment fund owned by Banco Santander, S.A., and managed by Optimal Investment Management Services, S.A. (collectively, “the defendants”). Optimal U.S. invested all of its assets in the infamous Bernard L. Madoff Investment Securities LLC. The plaintiffs alleged that the defendants violated Section 10(b) of the Exchange Act by “fail[ing] to conduct adequate due diligence, ignor[ing] red flags, and ma[king] misstatements and omissions in connection with the sale of Optimal U.S. shares . . . .” Although they conceded that the purchase and sale of the shares took place outside the United States, the plaintiffs alleged that the Exchange Act still reached their claims under two theories: 1) the purchase was “in connection with” trades made in the United States; and 2) the defendants’ investments constituted an “economic reality” of trades made in the United States.

The court rejected the first theory, noting that the presumption against extraterritorial application of the Exchange Act foreclosed a broad interpretation of the phrase “in connection with” in the context of extraterritoriality. In addition, although SEC v. Compania Internacional Financiera, S.A. established that certain foreign securities that were “functional equivalents” of United States securities could be considered “in connection with” those securities, the Optimal U.S. shares and the domestic shares subject to Madoff’s trades were not “functionally equivalent” because the relationship between the two was “much more attenuated.”  See SEC v. Compania Internacional Financiera, S.A., No. 11 Civ. 4904, 2011 WL 3251813 (S.D.N.Y. July 29, 2011).

The court rejected the second theory on two grounds. First, the concept of “economic reality” had been employed in a prior case to dismiss claims based on a United States swap agreement that was held to be “economically equivalent” to German shares; the same concept could not be used in the “reverse situation” in an attempt to expand the reach of the Exchange Act. See Elliott Associates v. Porsche Automobile Holding, 759 F. Supp. 2d 469 (S.D.N.Y. 2010). Second, Optimal U.S. shares were not economically equivalent to any U.S.-listed shares, because the former did not have a “direct, one-to-one relationship” with the latter.

Because the court held that the strong presumption against extraterritorial application of the Exchange Act was not overcome by the plaintiffs’ two legal theories, it dismissed the plaintiffs’ securities claims brought under the Exchange Act, leaving only claims of common law fraud, negligent misrepresentation, and aiding and abetting fraud.

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


Jeremy Liles