On January 25, 2021, the United States Court of Appeals for the Second Circuit affirmed the dismissal of claims under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) against a Bermudan capital investment company (the “Company”) and its Chief Executive Officer and Chairman. Cavello Bay Reinsurance Ltd. v. Shubin Stein et al.
, No. 20-1371 (2d Cir. Jan. 25, 2021). The Court held that the claims, which were brought by a Bermudan corporation, were “predominantly foreign” and not regulated by Section 10(b).
Plaintiff-appellant’s claims are based on its participation in the Company’s private offering, and its allegations that the Company made material misrepresentations regarding the Company’s fee arrangement with a third-party manager that was owned by the Company’s CEO. According to plaintiff-appellant, the CEO had represented that the third-party manager would receive incentive fees based on the Company’s profits and failed to disclose that the actual fee arrangement allowed the third-party manager to receive fees based on capital raised through the private offering even when the Company was operating at a loss. The more pertinent factual allegations on the domestic application of Section 10(b), however, are that: (1) plaintiff-appellant is a Bermudan company with its principal place of business in Bermuda; (2) the Company is a Bermudan corporation with its principal place of business in New York; (3) the Company sent a draft subscription agreement to plaintiff-appellant from New York; (4) plaintiff-appellant signed the subscription agreement in Bermuda (which was countersigned by the Company’s CEO in New York); and (5) the parties transferred title to the shares at the closing in Bermuda. Moreover, the Company shares are not listed in any domestic exchange and are not otherwise traded in the U.S.
The district court dismissed the claims because (1) the parties incurred irrevocable liability in Bermuda, and thus the transaction was not “domestic” under Absolute Activist Value Master Fund Ltd. v. Ficeto
, 677 F.3d 60 (2d Cir. 2012), and (2) even if the transaction were domestic, the claims were so predominantly foreign and thus impermissibly extraterritorial under Parkcentral Global HUB Ltd. v. Porsche Automobile Holdings SE
, 763 F.3d 198 (2d Cir. 2014) (“Parkcentral
”). The Second Circuit affirmed on the latter basis but declined to rule on the former.
With respect to the first basis of the district court’s dismissal—i.e.
, whether the transaction was “domestic”—the Court stated that because the allegations “ping-pong[ed] between New York and Bermuda,” “the place of transaction [was] difficult to locate, and impossible to do without making state law.”
With respect to the second basis of the district court’s dismissal—i.e.
, whether the claims were “so predominantly foreign as to be impermissibly extraterritorial,” the Court noted that the focus of the inquiry is “upon purchase and sales of securities in the United States,” not “upon the place where the deception originated.” Based on these principles, the Court held that the claims here were “so predominantly foreign” that Section 10(b) did not apply, even if the transaction could be considered “domestic.”
First, the claims were based on a private agreement for a private offering between a Bermudan investor and a Bermudan issuer. Second, the shares purchased in that offering reflected “only an interest in [the Company],” and the shares were not listed or traded in the U.S. Third, the “main link” to the U.S. was a requirement in the subscription agreement that plaintiff-appellant must register the shares with the SEC before reselling them, but that was merely a “contingent and future” SEC registration requirement and did not trigger some U.S. interest or other interest that the Exchange Act is meant to protect. Finally, the Court noted that sophisticated institutional investors could have structured a U.S. transaction if they “had wanted the regulatory hand of U.S. law,” but they instead structured the transaction “to avoid the bother and expense (and taxation) of U.S. law.”
This decision highlights a circuit split between the Second Circuit and the Ninth Circuit regarding the extraterritorial reach of Section 10(b). In Toshiba Corp. v. Automotive Industries Pension Trust Fund
, No. 16-56058 (9th Cir. July 17, 2018), the Ninth Circuit ruled that the “predominantly foreign” test in Parkcentral
is “contrary to Section 10(b)” and “carves out ‘predominantly foreign’ securities fraud claims from Section 10(b)’s ambit, disregarding Section 10(b)’s text.” The Supreme Court previously denied the petition for certiorari in Toshiba
, and it is possible that plaintiff-appellant here will seek certiorari in view of this split. (We previously covered the Ninth Circuit’s decision in Toshiba here
, and the Supreme Court’s denial of certiorari here