Morrison, the Second Circuit, and the Reverse Effects Test: ParkCentral Global Hub Limited v. Porsche Automobile Holdings (Part 2)
We are discussing the Second Circuit's decision in ParkCentral Global Hub Limited v. Porsche Automobile Holdings, a case that effectively created a "reverse effects test" that was contrary to the Supreme Court's analysis Morrison v. National Australia Bank.
In ParkCentral Global Hub Limited v. Porsche Automobile Holdings, the court addressed the full implications of the reasoning in Morrison. The case involved foreign defendants, foreign companies, foreign conduct, and losses based on price movements of foreign securities. Nonetheless, the transaction was alleged to have occurred in the United States.
The court had to squarely confront whether in fact conduct and the nature of the action were irrelevant to the analysis as Morrison indicated. The court concluded that while the transaction had to be domestic or involve a listed security, such a condition was necessary but not sufficient. Id. ("we conclude that, while a domestic transaction or listing is necessary to state a claim under § 10(b), a finding that these transactions were domestic would not suffice to compel the conclusion that the plaintiffs' invocation of § 10(b) was appropriately domestic.").
The opinion reasoned by negative implication, noting that Morrison never said that such factors were sufficient. It also concluded that the alternative would conflict with the determination that Section 10(b) did not have extraterritorial application.
The reasoning of the opinion is thin. Having found that the test in Morrison could largely be disregarded, the court simply concluded that Congress, back in 1934, did not intend in a sub silentio manner to permit actions that could conflict with the laws of foreign jurisdictions. The court relied not on citations to the legislative history or to the language of the statute but to what it viewed as an “obvious” possibility that must have been considered.
The reasoning reflects a result oriented decision. The court was concerned that, by allowing actions based solely on the domestic/listed nature, actions would be permitted under Section 10(b) that had few domestic implications. Nonetheless, such an implication was hardly lost on the Supreme Court. The Supreme Court deliberately sought to render the nature of the parties and the location of the fraudulent behavior irrelevant.
The Second Circuit was appropriately concerned with the implications of the test set forth by the Supreme Court in Morrison. But by implementing an effects test , the Second Circuit did so in only one direction. By allowing consideration of the effects only for transactions that were domestic or for securities that were listed, the effects test was only used to deny the availability of Rule 10b-5.
Nothing in the test employed by the Second Circuit suggested that it would be used to allow shareholders to bring an action under the antifraud provisions that clearly implicated US interests but did not involve a domestic transaction or listed security. This could occur, for example, where a US shareholder bought shares in a US company and alleged fraudulent behavior that occurred in the US but was prohibited from using Section 10(b) under the Morrison framework because the sale closed outside the United States. Yet while the Second Circuit devised a formula that would exclude actions by foreign shareholders that did not reflect a sufficient domestic interest, the court did not seek to expand the test to include actions by domestic shareholders that did have such an interest. In short, the Second Circuit developed a reverse effects test.
The court effectively acknowledged the almost legislative nature of the decision, suggesting that the task was more appropriately handled by Congress or the Commission. In fact, a legislative change is sorely needed in this area. The current test for applying Section 10(b) (the location of the transaction or the listed nature of the security) is based upon an arbitrary formula that does not reflect the domestic interests of the parties or the location of the behavior. The decision in Porsche has made the standard even more arbitrary.