U.S. Supreme Court Rejects F-Cubed Litigation

Canadian Class Action Scene May Feel Impact

Written By Michael Eizenga and Keir Wilmut

A recent ruling by the Supreme Court of the United States has greatly reduced the risk of Canadian securities issuers being embroiled in class action lawsuits in the U.S. Now, in order for a class action to be commenced in the U.S. against a foreign securities issuer, a share transaction must have taken place within the U.S.

While this change will reduce the risk of a Canadian issuer being sued in the U.S., the number of securities class actions brought in Canada is expected to increase.

History

Section 10(b) of the U.S. Securities Exchange Act states:

It shall be unlawful for any person… 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… any manipulative or deceptive device or contrivance…

U.S. Securities and Exchange Commission Rule 10b-5 contains a similar prohibition.

During the 1960s and 1970s, American courts began to interpret these statutory provisions in an extraordinarily broad manner. They developed a conduct test and an effects test: if anything more than “merely preparatory” conduct of an alleged wrongdoing had taken place in the U.S. or if the wrongful conduct had substantial effects in the U.S. or on U.S. citizens, a law suit could be brought in an American court.

As a result, with often only the most tenuous connection to the U.S., foreign investors could sue foreign issuers to recover alleged damages suffered from purchases on foreign securities exchanges.

Driven by American class-action lawyers, so-called F-Cubed cases (named for the three foreign elements) proliferated in American courts and presented a real risk for companies around the world. For example, a Canadian company who lists on the Toronto stock exchange could be subject to a class action brought by Canadian investors in an American court.

Eventually, approximately 15 percent of securities class actions in American courts were being brought against foreign companies. The potential for damages was huge: in 2010 an American jury awarded shareholders (only 25 percent of whom were American) in the French company Vivendi more than $9 billion in damages. Further, the conduct and effects tests were variably applied and generated inconsistent outcomes.

The End

In June of 2010, the Supreme Court issued its decision in Morrison v. National Australia Bank Ltd. and ended F-Cubed litigation.

Australian investors had purchased shares in National Australia Bank on various foreign (i.e. non-American) exchanges. In 1998, National Australia Bank acquired a mortgage provider in Florida. Three years later, the bank wrote down the value of this mortgage provider's assets, causing the bank's share prices to fall. The investors alleged that they had suffered losses due to false and misleading statements the bank had made about this Florida mortgage provider, and sought to sue in the U.S.

The Supreme Court held that they could not. Going even further, the Court held that for more than 40 years lower courts had been misinterpreting Section 10(b) by using the conduct and effect tests in determining the extraterritorial application of section 10(b).

Justice Scalia, writing for the majority, relied on the longstanding presumption of interpretation that in the absence of an evident contrary intent, legislation of congress is meant to apply only within the territorial jurisdiction of the U.S. Finding that it “contains nothing to suggest it applies abroad,” the Court created a clear test whereby Section 10(b) and Rule 10b-5's application is limited to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities”.

In other words, there is now a bright line test. It is no longer enough that some fraudulent activity occurred in the U.S. – even if that activity was a material part of the fraud. The reach of Section 10(b) and Rule 10b-5 is limited to fraud in connection with securities listed on American exchanges, or otherwise bought or sold in the U.S.

The Effect

As a result of the end of F-Cubed lawsuits, we may see five main effects:

1. Canadian issuers face a greatly reduced risk of being sued in American courts.
2. Filling this gap, the number of securities class actions brought in Canada may increase.
3. Canadian and American plaintiff firms may begin to co-operate more, bringing similar but separate cases at the same time on both sides of the Canada-U.S. border.
4. Over time, non-American jurisdictions may begin to offer more robust protection for investors buying shares listed on their national exchanges. If they do not, investors may decline to purchase shares in their jurisdiction for fear of not having a remedy.