Full text for verification

Extraterritorial Application of US Securities Law – Will the US Become the Default Jurisdiction for

Canonical record: https://ssrn.com/abstract=1664809

38 protected claims are extracted from this work.

Source extraction SHA-256: d41036a310a789e4c7ba2cd221eaa7faebbd86c8b66eb14c80736238dfc063f5

---

**ARTICLE**

# Extraterritorial Application of **US** Securities Law: Will the **US** Become the Default Jurisdiction for European Securities Litigation?

**WULF A.** KAAL, **MISSISSIPPI COLLEGE SCHOOL** OF LAW* **AND** RICHARD W. PAINTER, **UNIVERSITY** OF **MINNESOTA** LAW **SCHOOL**

## **1. INTRODUCTION**

**US** law applies to non-US residents and non-US entities in a variety of contexts. The Alien Tort Claims ActI allows **US** courts to hear some human rights cases brought **by** foreign citizens for conduct committed outside the United States.<sup>2</sup> Similarly, **US** courts have held that the **US** Bankruptcy Code does not require the presence of assets in the United States for ancillary insolvency proceedings against a foreign debtor.<sup>3</sup> In securities regulation, the **SEC** has continuously expanded its extraterritorial reach with strong support from the judiciary, most notably the Second Circuit Court of Appeals.<sup>4</sup>

Many **US** commentators are concerned about this trend. John Bellinger, the former Legal Advisor to the **US** Department of State, for example, has urged that the United States not become a'world court' for apartheid abuses in South Africa or similar claims.<sup>5</sup> Securities law commentators have criticized the extraterritorial reach of **US** laws<sup>6</sup> and the potential impact on Europe

in particular.<sup>7</sup> One commentator, Margaret Sachs, thoroughly researched the legislative history of the **1933** Securities Act and the 1934 Securities Exchange Act and found substantial evidence that Congress intended these laws not to reach transactions in foreign markets, but instead only transactions within the United States.<sup>8</sup> Commentators outside the United States have also expressed dissatisfaction with the 'long arm' of **US** law, and in particular **US** securities law.<sup>9</sup>

The **US** Supreme Court, in a case to be decided later this year, _Morrison v. National Australia Bank,to_ may curtail the jurisdiction of **US** courts in cases where foreign plaintiffs sue foreign defendants over securities purchased in foreign securities markets. At the same time, Congress could move in the opposite direction. Section **7216** of the Wall Street Reform and Consumer Protection Act of **2009,11** not yet enacted but pending in Congress, could expand the extraterritorial jurisdiction of **US** courts in these cases. This could have lasting implications for European jurisdictions, companies, attorneys, investors, and financial institutions.

E-mail: Kaal0mc.edu.

**1 28 U.S.C.** s. **1350** (stating in part: 'The district court shall have original jurisdiction of any civil action **by** an alien for a tort only, committed in violation of the law of nations or a treaty of the United States').

- 2 The Supreme Court in _Sosa v. Alvarez-Machain_ **(03-339)** 542 **U.S. 692** (2004), **331 F.3d** 604, tried to curtail the types of cases that are actionable under the Alien Tort Claims Act holding that new causes of action based on violations of international law norms'should **be** undertaken, if at all, with great caution' _Id.,_ **287.**

- **3** _See Haarhuis v. Kunnan Enters, Ltd.,_ **177 F.3d 1007,** 1012 **(D.C.** Cir. **1999),** holding that s. 304 of the **US** Bankruptcy Code does not expressly require the presence of assets in the United States for ancillary insolvency proceedings against a foreign debtor.

- 4 Roberta **S.** Karmel,'The Second Circuit's Role in Expanding the SEC's Jurisdiction Abroad, _St. Johns Law Review_ **65 (1991):** 743.

- **5 See** John B. Bellinger Ill,'The **U.S.** Can't Be the World's Court **-** New York Isn't the Right Venue to Sue for Apartheid Abuses', WSJ, **27** May **2009,** <http://online.wsj.com/articlel SBl **24338378610356591** .html>.

- **6** See, for example, Stephen **J.** Choi **&** Linda **J.** Silberman,'Transnational Litigation and Global Securities Class Action Lawsuits', _Wisconsin Law Review_ **2009 (2009):** 465; Stephen Choi **&** Andrew Guzman,'Portable Reciprocity: Rethinking the International Reach of Securities Regulation, _Southern California Law Review_ **71 (1998): 903, 927** ('with such expansive jurisdiction, even if a judgment is granted, foreign legal action may be required to enforce it').

**7** See, for example, Andrew Longstreth,'Coming to America, _American Lawyer,_ November **2006, 11/2006** Am. Law. **S53** (Westlaw); Mary Jacoby,'For the Tort Bar, a New Client Base: European Investors, _Wall Street Journal,_ 2 September **2005, Al.**

**8** Margaret V. Sachs,'The International Reach of Rule **10b-5:** The Myth of Congressional Silence, _Columbia Journal of Transnational Law_ **28 (1990): 677, 700-701.**

- **9** See, for example, Oliver Kn6fel,'Whistleblowing und Sarbanes-Oxley **-** Kein Extraterritorialer Arbeitnehmerschutz?', _Recht der Internationalen Wirtschaft_ **7 (2007):** 493, 494; Sascha Lotze, _US-amerikanisches Kapitalmarkrsrecht und Internet_ (2002), **78;** Peter Versteegen, K61ner Kommentar zum **WpOG (2003),** s. 24 **WpOG,** 34; Rainer Sulmann, Geibel/Sifllmann Kommentar zum **WpOG,** s. 24 **WpOG, 8;** Jan von Hein, Grundfragen des europAischen Obernahmekollisionsrechts, **5 AG 213,** 224 (2001); Timo Holzborn, Ausschluss auslindischer Aktion5re nach s. 24 **WpCG** -'Die Disclaimer Problematik', 2 BKR **67, 73-76** (2002); Oliver Klepsch, Steinmeyer/Hlger, Kommentar zum **WpOG,** s. 24 **WpOG, 10.**

**10** 547 **F.3d 167, 172 (2d** Cir. **2008).**

**11** The Wall Street Reform and Consumer Protection Act of **2009** (Introduced in House), H.R. 4173; **111th** Congress, **s.7216.** Extraterritorial Jurisdiction of the Antifraud provisions of the Federal Securities Laws.

Kaal, Wulf **A. &** Richard W. Painter.'Extraterritorial Application of **US** Securities Law: Will the **US** Become the Default Jurisdiction for European Securities Litigation?' _European Company Law_ **7,** no. **3** (2010): **90-97.** @ 2010 Kluwer Law International BV, The Netherlands

# **_2. MORRISON V. NATIONAL AUSTRALIA BANK_**

**US** courts have analysed the question of whether section **10(b)** of the 1934 Securities and Exchange Act<sup>12</sup> and **SEC** Rule **10b-5** can be applied to foreign litigants in securities fraud cases as a question of subject matter jurisdiction. The most frequently used approach is the Second Circuit's so-called 'conduct and effects' test, which looks at whether conduct contributing to the violation took place in the United States or whether the conduct had an effect on **US** investors.<sup>13</sup> **US** courts have avoided a bright line rule to determine which cases can be litigated in **US** courts and which cannot. As a result, **US** courts apply the conduct and effects test inconsistently. 14 This inconsistency is especially problematic in the context of 'foreign cubed' litigation,<sup>15</sup> that is securities lawsuit involving a foreign plaintiff suing a foreign issuer in a **US** court for violations of **US** securities laws based on securities transactions in a foreign country.<sup>16</sup>

The Supreme Court in _Morrison v. National Australia_<sup>_Bank17_</sup> may bring some clarity to this issue. Morrison and other Australian plaintiffs had purchased shares of National Australia Bank **(NAB)** in Australian securities markets. They sued **NAB** in federal court in New York under section **10(b)** alleging that **NAB** had misrepresented to shareholders its exposure to bad mortgages in a Florida subsidiary and that conduct in Florida caused this misrepresentation because Florida employees had altered financial statements. The Second Circuit applied the conduct and effect test and found an insufficient connection between the alleged securities fraud and the United States to allow the suit to go forward, in part because the alleged misrepresentations to investors had been made in Australia rather than in Florida. Plaintiffs asked the Supreme Court to review the case and the Supreme Court agreed to do so. Briefs were filed in early **2010** and oral argument was heard in March 2010.

**A** group of twenty-one **US** law professors, including the authors of this article, submitted an amicus brief to the Supreme Court in Morrison asking the Court to ensure that private parties outside the United States not be allowed to use **US** courts to litigate claims that exceed the subject matter that Congress intended to regulate in section **10(b).** The professors discussed the detailed legislative history compiled **by** Professor Margaret Sachs, who joined the amicus brief, and concluded that Congress had intended the federal securities laws only to cover purchases and sales of securities within the United States. The professors also observed that as a matter of policy, it was better to have a bright line rule that would allow civil suits under section **10(b)**

only in connection with securities purchased or sold within the United States. First, issuers and investors should know in advance whether **US** law applies to their transactions, whether foreign law applies, or both. Issuing and investing in securities should not be a guessing game, and the 'conduct and effect' test of the Second Circuit was too unpredictable. **A** clear rule focused on the location of the transaction would be more predictable. Second, allowing foreign plaintiffs to sue foreign defendants in **US** courts over securities purchased and sold in foreign countries would turn the United States into the global arbiter of securities fraud allegations, causing significant damage to **US** foreign relations and undermining international cooperation in combating securities fraud. Third, imposing the **US** system of securities litigation on the rest of the world could lead to suboptimal outcomes given the sharp differences between the United States and most other countries in substantive securities law, procedural law, and the way class actions are administered. Many countries, the professors pointed out, choose to combat securities fraud with government enforcement rather than private litigation, and the United States should respect the right of other countries to regulate their own markets.

Morrison and the other plaintiffs, on the other hand, have urged the Court to retain the conduct and effects test and also to find that the Second Circuit applied the test too narrowly in their case when it refused to find jurisdiction. Most of the conduct that perpetrated the fraud, plaintiffs claim, occurred in Florida, and the United States has a legitimate interest in protecting foreign investors from fraud perpetrated within its borders, regardless of where the security is purchased or sold. Congress in **1933** and 1934, plaintiffs urged, also had intended the federal securities laws to apply in these situations. Plaintiffs cited very little legislative history to support this argument. Plaintiffs instead argued that the expansive language of section **10(b)** itself required the Court to apply section **10(b)** to cases involving fraudulent conduct within the United States that affects markets elsewhere.

# **3. CONGRESS MAY SUBJECT NON-US SECURITIES TRANSACTIONS TO US SECURITIES LITIGATION**

Regardless of the Supreme Court's ruling in _Morrison v._ **_NAB,_** Congress could overrule the holding in that case because this is a matter of statutory construction. The Court is being asked to interpret an Act of Congress, and Congress may respond to an interpretation it does not like **by** amending the Act.

In the aftermath of the **2008** financial crisis, there is reason to worry that Congress may do that. **US** investment banks including

12 **15 U.S.C.** s. **78j (2006).**

> **13** For a thorough discussion of case law, see Erez Reuveni,'Extraterritoriality as Standing: **A** Standing Theory of<sup>the</sup> Extraterritorial<sup>Applicationof the SecuritiesLaws,</sup><sup>_UCDavis_</sup> _Law Review 43_ (2010): **66,** Part **I,** <http://ssrn.com/abstract=1496049>.

> 14 _Ibid._

> **15** See Hannah L. Buxhaum,'Multinational Class Actions under Federal Securities Law: Managing Jurisdictional Conflict, _Columbia Journal of Transnational Law_ 14 **(2007): 17. 16** _See Morrison v. National Australia Bank Ltd.,_ 547 **F.3d 167, 172 (2d** Cir. **2008).** The Supreme Court granted certiorari in _Morrison v. National Australia Bank_<sup>_Ltd.,_No.</sup><sup>**08-1191,**</sup> **2009** WL 4111014 **(U.S. 30** Nov. **2009).**

> **17** 547 **F.3d 167,172 (2d** Cir. **2008),** No. **08-1191, 2009** WL 4111014 **(U.S. 30** Nov.<sup>**2009).**</sup>

**JUNE** 2010, **VOLUME 7, ISSUE 3**

**91** -

**EUROPEAN** COMPANY LAW

Goldman Sachs have been accused of designing deceptive derivative securities transactions that were used **by** the government of Greece to conceal the fact that its debt levels exceed those allowed **by** the European Union **(EU).** The difficulties of Greece and the role of **US** investment banks illustrates the impact that conduct within the United States can have on world markets. In the Lehman Brothers bankruptcy, a court-appointed bankruptcy examiner alleged that Lehman hid debt on its balance sheet at the end of each quarter **by** selling assets **-** including mortgage backed securities **-** for a few days to banks in London that were promised that Lehman would repurchase (repo) the same assets for cash at the beginning of the next quarter, with the same arrangement being repeated at the end of the following quarter. **US** law firms refused to opine that the transaction was a true sale of the assets under **US** law, but a **UK** law firm did opine that the transaction was a true sale under **UK** law if the reported value of the assets was **105%** of the sale price. The transaction, called 'Repo **105'** was consummated in London, and Lehman's auditors opined that Lehman could book the transaction as a sale on its financial statements in its **US** securities filings. This incident underscored the affect that conduct in one country can have on markets elsewhere.

Congress could respond to these and other allegations of transnational securities fraud **by** passing legislation that provides financial and other support for international cooperation among regulatory authorities in combating securities fraud and regulating securities markets. Congress also, however, could support unilateral **US** action as Congress has done in its approach to combating terrorism and some other global problems. Congress thus could expand the jurisdictional reach of the **SEC** as well as the subject matter jurisdiction of **US** courts over private suits involving purchase and sale of securities on foreign markets.

Congress is currently considering a bill introduced last year, The Wall Street Reform and Consumer Protection Act of **2009,**

H.R. **5173.18** Section **7216** of H.R. **517319** (section **7216)** would explicitly provide for extraterritorial jurisdiction with respect to anti-fraud provisions in the federal securities laws if there is'conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors'. This 'significant steps' standard is probably broader **-** and covers a wider range of defendants **-** than the Second Circuit's 'conduct and effect' test, which arguably covers only conduct in the United States that directly causes the misrepresentation to foreign investors.<sup>20</sup> The proposed language covers the Securities Act of **1933 -** section 22,21 the Securities Exchange Act of 1934 **-** section **27,22** and the Investment Advisers Act of 1940 **-** section 214.23 As of this publishing, it is unclear whether Congress will enact this language and whether the final version of the bill will include section **10(b)** of the Securities Exchange Act of 1934, the provision under which private plaintiffs sued _in Morrison v._ **_NAB_** and in most other similar cases. **If** this bill is enacted and if it does include section **10(b),** Professor John Coffee has correctly observed that'the United States could become a magnet for global class actions'.<sup>24</sup> **US** lawyers may benefit from 'securities litigation tourism' just as lawyers in the United Kingdom have benefited from 'libel tourism' in which aggrieved parties from around the world take advantage of expansive **UK** libel laws to bring suits in the United Kingdom claiming that their reputations were damaged in the United Kingdom. It is unlikely, however, that turning any single country into a global litigation mill for a particular subject matter **-** whether securities law or libel law **-** enhances that country's role in the world economy.

# **4. THE IMPACT OF TRANSNATIONAL SECURITIES LITIGATION**

In the past decade, **US** courts have faced a rise in foreign cubed cases.<sup>25</sup> In **2008,** foreign cubed cases exceeded any previous year

**18** H.R. 4173; **11Ith** Congress **-** Introduced in House of Representatives.

**19 § 7216,** Extraterritorial Jurisdiction of the Antifraud Provisions of the Federal Securities Laws:

|(a)UndertheSecuritiesActof**1933-** Section22oftheSecuritiesActof**1933(15U.S.C.**77v(a))[Under the SecuritiesExchangeActof1934**-** Section**27**ofthe Securities|
|---|
|ExchangeActof1934**(15U.S.C.**78aa)**(...and]**UndertheInvestmentAdvisersActof1940**-** Section214oftheInvestmentAdvisersActof1940**(15U.S.C.80b-14)**is<br>amended**by**addingat theendthefollowingnewsubsection:|
|(c)Extraterritorial Jurisdiction**-** Thejurisdiction ofthedistrictcourtsofthe UnitedStatesandtheUnited StatescourtsofanyTerritorydescribedundersubsection(a)|
|includesviolationsofSection17(a),andallsuitsinequityand actionsatlawunderthatsection,involving**-**|
|**(1)**conductwithin theUnitedStatesthatconstitutessignificantstepsinfurtheranceoftheviolation,evenifthesecuritiestransactionoccursoutsidetheUnitedStatesand<br>involvesonlyforeign investors;or|
|(2)conduct occurring outsidetheUnitedStatesthathasaforeseeablesubstantialeffectwithintheUnited States.|

20 _See Bersch v. Drexel Firestone, Inc.,_ **519 F.2d** 974, **993 (2d** Cir. **1975).** Bersch found that s. **10(b)** applied when'all the elements of a defendant's conduct necessary to establish a violation' occurred in the United States. Subsequent case law applying the conduct and effects test has reached a broader range of conduct, but it is unclear how broad. 21 **15 U.S.C.** 77v(a).

> 22 **15 U.S.C.** 78aa.

**23 15 U.S.C. 80b-14.**

24 John **C.** Coffee, Jr.,'High Court and Congress on a Collision Course, Nat'l **L.J. (18** Jan. 2010). **25** See Cornerstone Research, 'Securities Class Action Filings **2009:** Mid-year Assessment', <http://securities.cornerstone.com/pdfs/2009_Mid-Year Assessment.pdf>, **2009, 7.** See also Cornerstone Research, 'Securities Class Action Filings **2009:** Mid-year Assessment News Release, <http://securities.cornerstone.com/pdfs/2009_Mid-YearRelease. **pdf>, 2009,** I (elaborating that: 'This report introduces a new metric, the Class Action Filing-Foreign Index **(CAF-F** Index-), that measures the number of securities class action filings in **U.S.** federal courts against defendant corporations headquartered outside the United States. Federal securities class action lawsuits against issuers with non- **U.S.** headquarters ("foreign firms") have been rising for more than a decade and reached **31** filings **(13.8** percent of total filings) in **2008,** with an average of **18** foreign firms (9.4 percent of total filings) sued in each year since **1997.** Thus far in **2009, 18** lawsuits have been filed against foreign firms, representing **20.7** percent of the total').

**. 92 --**

**JUNE** 2010, **VOLUME 7,ISSUE 3**

**EUROPEAN** COMPANY LAW

and the trend is continuing.<sup>26</sup> One reason for this development could be a lack of securities class actions in European jurisdictions.<sup>27</sup> This void increases incentives for forum shopping **by** plaintiffs' lawyers. Forum shopping **by** foreign plaintiffs may also result from a tendency in the United States towards higher judgments and settlements.<sup>2</sup> 8 The effect will be magnified if **US** courts can be persuaded to intervene in shareholder derivative suit claims and other disputes under the laws of an issuer's state or country of incorporation.

For European jurisdictions, the extraterritorial application of **US** law can create confusion, legal uncertainty, and difficulties regulating private parties that engage in regulatory arbitrage **by** taking their litigation to the United States when it is convenient for them to do so. European jurisdictions may also feel compelled to change their laws to conform with **US** law. European plaintiffs' attorneys may **be** able to utilize **US** legal remedies and other benefits of the **US** legal system, but they are exposed to competition with **US** attorneys who have an advantage in conducting **US** litigation.

Finally, there is the enormous impact of transnational securities litigation on non-US companies. Increasing the extraterritorial application of **US** law could mean that European companies will be exposed to **US** law even if they are not cross-listed companies that choose to sell American Depository Receipts (ADRs) or other securities in the United States. Under an expansive **US** litigation regime, many companies will be covered **by US** securities law if they have any operations in the United States where conduct causing securities fraud elsewhere could be alleged. This could have lasting implications for the financial reporting, corporate governance, and business operations of European companies.

Combined, all of these trends could have long-term effects on international relations, diplomacy, and cross-border investment. Some of these effects are discussed in more detail below.

# **4.1.** European **Jurisdictions and European Companies**

Forum shopping **by** lawyers **-** both **US** lawyers and European lawyers **-** representing European plaintiffs is incentivized **by**

attractive features of the **US** legal system such as the availability

of securities class actions, a tendency towards higher damages and settlement amounts, little or no exposure of plaintiffs to liability for defendants' legal fees even if the defendants prevail, and the possibility of including some aspects of derivative actions in their claims. **If** section **7216** becomes law and allows the extraterritorial application of **US** anti-fraud provisions, this law could further incentivize forum shopping **by** plaintiffs' attorneys. Over time, this may lead to assimilation of **US** law into the regulatory approaches of European jurisdictions that feel compelled to adopt portions of **US** law in order to discourage forum<sup>shopping.29</sup> Assimilation of **US** legal rules in turn may result in increased transaction costs for the changing jurisdiction.

Some aspects of **US** law could be quite troubling for **EU** jurisdictions. In securities class actions, for example,<sup>**US**lawallows</sup> plaintiffs to proceed on the basis of the 'fraud on the<sup>market</sup> theory' rather than requiring plaintiffs to prove actual reliance<sup>on</sup> misleading statements.<sup>30</sup> This approach has been rejected in most other countries.<sup>31</sup> The application of section **10(b)** of the 1934 Act<sup>32</sup> and Rule **10b-5** in conjunction with the fraud on the<sup>market</sup> theory substantially increases the potential liability of issuers<sup>and</sup> can lead to questionable results.<sup>33</sup> **EU** jurisdictions may not want this rule to apply to their securities markets. Under section<sup>**7216,**</sup> however, **US** law could apply to **EU** companies that are accused<sup>of</sup> conduct violating **US** securities laws, even if they have no securities traded in the United States.

Class actions involving all or mostly foreign plaintiffs<sup>alsogive</sup> rise to unique difficulties with class certification under Federal Rule of Civil Procedure **23** and identification of a lead plaintiff as required **by** the Private Securities Litigation Reform<sup>Act of</sup> **1995** (PSLRA).<sup>34</sup> The **SEC** itself has suggested that securities<sup>class</sup> actions present unique considerations and that'a more jurisdictionally restrictive standard may be warranted in the class<sup>action</sup> context'.<sup>35</sup> Section **7216 by** contrast suggests that Congress<sup>could</sup> be on the verge of ignoring this advice and establishing a more expansive class action regime instead.

Many countries have made different decisions than the United States about trade-offs between the interests of plaintiffs<sup>and the</sup> interests of defendants in class action litigation. These decisions shape both substantive law and procedural law. Some countries

**26** See Stanford Law School Securities Class Action Clearinghouse **&** Cornerstone Research, 'Securities<sup>Class ActionFilings</sup><sup>**2009: A**YearinReview,<http://securities.stanford.</sup> edu/clearinghouse-research/2009_YIR/CornerstoneResearch-Filings_2009_YIR.pdf>, 2010, **I1.**

**27** See Buxbaum, _supra_ n. **15, 61.**

**28** See Christof Aha **&** Jens F6derer,'Die Roche **-** Entscheidung des **U.S.** Court of<sup>Appeals',</sup><sup>_Recht der Internationalen Wirtschaft_</sup><sup>**6(2003):**450,451.</sup> **29** _See ibid.,_ 458; Bernd Schunemann,'The Sarbanes-Oxley Act of 2002: **A** German Perspective,<sup>_Buffalo_</sup> _Criminal_<sup>_Law Review_</sup><sup>**36**(2004): 35,49;see Holzborn,</sup><sup>_supra_n.</sup><sup>**9.**An exam-</sup> ple of assimilation of legal norms is the introduction of the derivative suit in s. 148 AktG (German Corporation Act) and the German business judgment<sup>rule ins.</sup><sup>**93**</sup> **12**<sup>AktG.</sup> Both of these provisions are modelled after the **US** example albeit certain elements were added. In the case of the German<sup>derivative suit, a requirementof stockownershipof</sup> at least **EUR 100,000** was added to avoid frivolous suits. **30** _See Basic, Inc. v. Levinson,_ 485 **U.S.** 224 **(1988). 31** See Buxbaum, supra n. **15, 61. 32** 48 Stat. **881, 15 U.S.C.** s. 78a et seq. (enacted **6** Jun. 1934). **33** Aha **&** Foderer, _supra_ n. **28,** 456. 34 See Stephen **J.** Choi **&** Linda **J.** Silberman,'Transnational Litigation and<sup>Global SecuritiesClass ActionLawsuits,</sup><sup>_Wisconsin Law Review_</sup><sup>**2009 (2009):**465, 479(discussingthese</sup> difficulties).

**35** Brief of the Securities Exchange Commission as amicus curiae in _Morrison v. Australia National Bank_<sup>in response tothe court's request, 4,n.</sup><sup>**1,**547</sup><sup>**F.3d167 (2d**Cir.</sup><sup>**2008).**</sup>

**JUNE** 2010, **VOLUME 7, ISSUE 3**

**93** -

**EUROPEAN** COMPANY LAW

reject class action litigation entirely because they believe that it is too expensive, because it encourages frivolous litigation, because it does not deter securities fraud, or for other reasons.<sup>3 6</sup> Not every country wants a class action litigation system or wants its securities markets subject to one. It would be preferable for other nations to make this choice for themselves. Once again, section **7216** could have the opposite effect of forcefully exporting **US** law on other jurisdictions, including Europe.

# **4.2.** Overlapping Regulation

The application of the **US** Sarbanes-Oxley Act of **200237** to foreign companies illustrates the impact of extraterritorial application of **US** law. Many of the provisions of the Sarbanes-Oxley Act do not correspond with the applicable law in Member States of the **EU** and the respective rules, regulations, and initiatives of the **EU.**<sup>**38**</sup> **A** European company, however, has some ability to avoid the Sarbanes-Oxley Act if it avoids listing its securities in the United States. Another example of overlapping regulation<sup>39</sup> is the investigation of United States and European companies **by** multiple regulators from different jurisdictions for payments to foreign government officials.<sup>40</sup> Perhaps the most significant case to date is the Siemens bribery investigation involving the **US** Department of State, the **SEC,** and the Public Prosecutor in Munich, Germany. Siemens implicitly acknowledged its exposure to disparate and overlapping regulation **by** pleading guilty on several counts and simultaneously settling with the **US DOJ, SEC,** and the Munich Prosecutors Office.<sup>41</sup>

Currently, cross-listed companies, that is, companies that are listed on their home stock exchange as well as a foreign exchange, are more likely to be exposed to conflicting legal requirements than companies that are only listed on their home stock exchange.

Increasing the extraterritorial application of **US** law through an expansive application **by US** courts of the 'conduct and effects' test or Congressional enactment of section **7216,** however, could mean that more European companies could be exposed to the anti-fraud provisions of **US** securities law whether or not their securities are traded in the United States. European companies could be faced with substantive legal requirements that are inconsistent with the substantive laws and corporate governance standards in their home jurisdiction.<sup>42</sup>

More specifically, **US** securities law could be inconsistent with the law in European countries on such basic questions as when issuers have a duty to disclose information to investors and what information is sufficiently material that issuers must disclose it. Because of **EU** privacy laws, contractual arrangements, or other considerations, a company could possibly be prohibited from disclosing information in **EU** jurisdictions that the company is required to disclose in the United States. **EU** companies that are cross listed in the United States have to deal with these problems because they voluntarily subject themselves to **US** securities law, but **US** foreign cubed litigation threatens to force these problems on other **EU** companies as well.

## **4.3. Legal Uncertainty**

Overlapping regulation and inconsistent legal rules create uncertainty.<sup>43</sup> Individual board members of European companies and their attorneys will not know which legal rules apply and what effects these rules may have. They will also face uncertainty when they assess the marginal cost and marginal benefits of complying with the perceived dominant legal system. Not knowing which legal system is dominant can make these decisions enormously difficult.

**36** See Samuel P. Baumgartner, 'Class Actions and Group Litigation in Switzerland, _Northwestern Journal of International Law_ **_&l_** _Business_ **27 (2007): 301, 310-312** ('proponents of such a [class action] device in Switzerland face considerable doctrinal, jurisprudential, cultural, and economic objections. Among them are a traditional focus on the individual nature ofa claim; limitation of judicial power vis- -vis the legislature, thus disallowing the large-scale judicial discretion necessary to manage complex litigation; strong emphasis on the litigants' right to be heard, which would need to be slighted in complex cases; different respective roles of judges and attorneys; lack of American-style fee structures and entrepreneurial lawyering; and the many practical changes that would be necessary to introduce a class action device. Moreover, there is a clear preference for legislation rather than litigation to deal with new social problems, including mass torts'). **37** Pub.L. 107-204, **116** Stat. 745 (enacted **30** Jul. 2002). **38** See, for example, Schunemann, _supra_ n. **29,** 49-50; Hans-Georg Kamann **&** Martina Simpkins, 'Sarbanes-Oxley Act: Anlass cu verstirkter Internationaler Kooperation?, Recht _der Internationalen Wirtschaft_ **3 (2003): 183,** 184.

**39** It is important to distinguish 'overlapping' from 'conflicting' regulation. Conflicting regulation could violate international law. The territorial integrity of a state is only breached **by** the extraterritorial application of foreign law and results in the breach of international law if there is a specific 'true conflict' in the substantive legal norms of the respective states. See Ulrich Stirmer, _Die extraterritoriale Anwendung Amerikanischer Anlegerschutzbestimmungen_ **_-_** _Ein Beitrag zum International Aktienverkehrsrecht aus Vdlkerrechtlicher Sicht unter Besonderer Beriicksichtigung des Insiderrechts_ (Peter Lang Verlag, Europaische Hochschulschriften, Reihe II, Bd/vol. **187, 1977), 17.** See also Karl **M.** Meessen,'Kollisionsrecht als Bestandteil des Allgemeinen Volkerrechts: VOlkerrechtliches Minimum und Kollisionsrechtliches Optimum, in _Festschriftfiir,_ ed. **F.A.** Mann, s. **227 ff.** _See Hartford Fire Insurance Co. v. California,_ **509 U.S.** 764 **(1993),** opining that: 'The only substantial question in this litigation is whether "There is in fact a true conflict between domestic and foreign law".'

40 Linda Chatman Thomsen, Dominick **D.** Barbieri **&** Mathew **S.** Miller,'Dealing with Multiple Regulators: Reflections on Parallel Investigations, Regulators' Differing Roles, and Issues to Consider in Representing Organizational Clients, in _Practicing Law Institute Corporate Law and Practice Course Handbook Series_ **(2009), 903, 922.** 41 See Statement of Offense, _United States v. Siemens Aktiengesellschaft,_ Cr. No. **08-367-RVC (D.D.C. 18** Dec. **2008),** <www.justice.gov/opaldocuments/siemens-ag-stmt-offense. **pdf>, 39;** see also David Crawford **&** Mike Esterl, 'Siemens Pays Record Fine in Probe, _Wall Street Journal,_ **16** Dec. **2008,** B2. For background and Siemens's reactions, see Siemens AG,'Corporate Communications **-** Rechtsstreitigkeiten **-** Geschiftsjahr **2007',** <www.siemens.com/press/pool/delevents/jahrespk2007/legal-proceedings-q4-2007- **d.pdf>,** November **2007.**

42 Kamann **&** Simpkins, _supra_ n. **38.** 43 See, generally, Helmut Wagner, 'Legal Uncertainty **-** Is Harmonization of Law the Right Answer?, Discussion Paper No. 444, <www.fernunihagen.de/FBWIWI/forschung/ beitraegelpdf/db444.pdf>, January **2009** (discussing and defining legal uncertainty<sup>generally).</sup>

**EUROPEAN** COMPANY LAW

**JUNE** 2010, **VOLUME 7, ISSUE 3**

-94 **-**

Legal uncertainty generates transaction costs.<sup>44</sup> European company boards will inevitably incur costs in minimizing information asymmetries generated **by** different legal regimes that may or may not apply to their company. Paying **US** lawyers for advice is one of these costs. Legal advice would include ascertaining the legal setting of business transactions **-** for example, whether there is sufficient conduct or effects in the United States for **US** securities laws to apply **-** and advice on litigating disputes over what legal rules may apply. For companies that want to avoid securities fraud allegations, there will also be the cost of compliance with two sets of legal rules.

The extraterritorial application of **US** law, if legitimized **by** Congress in section **7216,** could exacerbate legal uncertainty for European companies even further than it is already under the conduct and effects test. As discussed above, the proposed statutory language in section **7216** is arguably broader than the conduct and effects test. Relative to the total number of **US** securities fraud and securities class action cases,'foreign cubed' cases are now relatively rare<sup>45</sup> - although there has been a substantial increase in foreign cubed cases in **2008.46** Thus, most European companies are currently either not aware or are not concerned with potential legal risk, potential liability, or potential involvement in such suits. However, the enactment of section **7216** could make foreign cubed cases an integral part of the legal landscape in the United States and hence in Europe.

# 4.4. European Financial Intermediaries

**A** large proportion of **US** securities fraud cases involve banks, brokers, and other financial intermediaries. These intermediaries often have the 'deep pockets' that plaintiffs' lawyers are looking for. **If** section **7216** extends the application of **US** securities fraud provisions to non-US securities transactions, European financial intermediaries could become the dominant target for plaintiff's attorneys. European financial intermediaries could also change their procedures and operations to avoid **US** securities fraud litigation, putting them at a competitive disadvantage with **US** financial intermediaries that can do business in Europe without fear that European courts would subject them to suits **by US** plaintiffs over **US** transactions.

**EU** financial intermediaries, like **EU** issuers, are also at a competitive disadvantage in their interaction with the **US** political system. Campaign contributions have a substantial impact on public policy in the United States.<sup>47</sup> Plaintiffs' lawyers contribute

generously to **US** political campaigns. The **US** financial services industry, however, also ranks among the most generous donors to **US** political campaigns and **US** issuers of securities also contribute. Non-US individuals and companies, **by** contrast, are expressly prohibited **by US** law from contributing to **US** political campaigns.<sup>48</sup> Non-US business interests also have a relatively weak lobby in Washington, **DC.**

The balance of political power inside the United States has in the past two decades led to legislation that favours defendants over plaintiffs in securities litigation, including the PSLRA. This may change after the **2008** financial crisis, but perhaps it is no surprise that Congress is not seriously considering repeal of PSLRA, however, Congress is seriously considering section **7216.** PSLRA benefits all defendants including **US** financial intermediaries, but the defendants harmed **by** section **7216** will almost<sup>all</sup> be non-US financial intermediaries and issuers who are less able to defend themselves in the **US** political system.

# 4.5. European Lawyers

**US** attorneys compete with European attorneys. For instance, large New York-based **US** firms are often competing for the same clients with so-called magic circle firms in the United Kingdom and other large firms in mainland Europe. Recently, many companies in Europe and the United States suffered losses in the credit crisis and have reduced their payment of legal fees, forcing some law firms to file for bankruptcy, to downsize significantly, or to dissolve.<sup>49</sup> For **US** law firms representing plaintiffs and defendants, litigation involving securities transactions outside the United States is an attractive source of revenue.

Over the past decade, **US** plaintiffs' attorneys have expanded their client base with foreign investors and increased the scope of **US** securities class actions on a global scale.<sup>50</sup> **US** law firms may charge contingency fees. Plaintiffs' lawyers even if they lose a suit are protected **by** the American rule, under which each party is responsible for paying its own attorneys' fees. European law courts are more likely to apply the'English' rule, that is, the losing party pays the attorneys' fees of the prevailing party. **US** class actions are cost-effective for lawyers given the enormous amounts of money involved, and European jurisdictions mostly do not offer securities class actions as a remedy for litigants. In addition, the tendency in the United States towards higher judgments and settlements, as well as the possibility for derivative suits,<sup>5 1</sup> makes the United States a lucrative place to litigate for plaintiffs' and

44 _Ibid.,_ **6** (elaborating that:'Legal uncertainty generates the following transaction<sup>costs: (a)costsof collectinginformation,</sup><sup>**(b)**costsof legaldisputes, (c) costs of setting incen-</sup> tives for pushing through legal claims, and **(d)** other transaction costs').

45 See Stanford Law School, _supra_ n. **26** (the increase in foreign cubed cases started in **2008).** 46 See _ibid._

47 See Richard W. Painter, _Getting the Government America Deserves: How_<sup>_Ethics Reform Can Make a Difference_(OxfordUniversity Press,</sup><sup>**2009),Ch.11.**</sup> 48 In 1974, the prohibition on political contributions and expenditures **by**<sup>foreign</sup> nationals<sup>was incorporatedinto the FederalElectionCampaign Act,2</sup><sup>**U.S.C.**431et seq.</sup> 49 See Larry **E.** Ribstein,'The Death of Big Law, University of Illinois<sup>Law</sup><sup>**&**Economics ResearchPaperNo.</sup><sup>**LE09-025,**<http://ssrn.com/abstract=</sup><sup>**1467730>,2009.**</sup> **50** See Buxbaum, _supra_ n. **15,62.**

**51** Aha **&** Federer, _supra_ n. **28.**

**JUNE** 2010, **VOLUME 7,ISSUE 3**

--- **95** -

**EUROPEAN** COMPANY LAW

defendants' lawyers. While European law firms could participate in securities litigation in the United States, **US** law firms are at an enormous advantage as they will be perceived **by** clients to be familiar with **US** substantive and procedural law as well as the practical aspects of **US** litigation.

**If** section **7216** is enacted, European plaintiffs and defendants will likely turn to the expertise of American law firms. This will give **US** lawyers additional opportunities to expand an aggressive marketing campaign for legal services in Europe. The enactment of section **7216** thus could further exacerbate the already difficult situation for European law firms.

## **_4.6._** European Investors

**US** securities laws require issuers whose securities are sold or traded in the United States to disclose material information to investors and keep investors informed in a timely manner.<sup>52</sup> The **SEC** also requires all listed companies to file their reports on a centralized system that is accessible **by** investors, called EDGAR.

In Europe, each country is responsible for its own securities regulation and the **EU** has no central agency for securities regulation.<sup>53</sup> There is no centralized system like EDGAR for continuous disclosure of pertinent information to investors. Only fairly recently have European countries introduced mandatory and continuous issuer disclosure.<sup>54</sup> Such disclosure in Europe is often selfregulated rather than being enforced **by** a regulator.<sup>55</sup> The European Parliament and the European Commission have attempted to address disparate regulation and lack of enforcement in individual European Member States **by** adopting the Market Abuse Directive,<sup>56</sup> Transparency Directive,<sup>57</sup> the Markets in Financial Instruments Directive,<sup>58</sup> and the Prospectus Directive.<sup>59</sup> Despite many improvements,<sup>60</sup> the directives do not mandate coherent and comprehensive disclosure and issuers continue to make disclosures in disparate ways. Some scholars have argued that there is a need for a European **SEC.**<sup>**6 1**</sup> European investors continue to struggle

finding material information on European companies. Even if they find appropriate sources, the information may be incomplete.<sup>62</sup>

Given the state of securities regulation in Europe, European investors arguably are more exposed to securities fraud than **US** investors. On the other hand, the financial crisis of **2008** revealed a substantial amount of financial mismanagement, and fraud, **by US** issuers and financial intermediaries. Regardless of the relative merits of securities regulation in the United States and in Europe, European investors are most likely to benefit if Europe addresses this issue itself. Giving **EU** plaintiffs greater access to **US** courts to sue **EU** issuers and financial intermediaries for alleged violations of **US** law may look attractive to **EU** investors in the short term, but if the **US** litigation system imposes substantial costs on **EU** companies, these costs will be passed on to investors. **If** Congress enacts section **7216, EU** investors will, on the whole probably, earn a lower return on their investments than they would otherwise.

# **4.7.** International Law

If section **7216** should pass, some litigants, commentators, and perhaps even national governments may argue that section **7216** is inconsistent with international legal rules governing extraterritorial jurisdiction. These include GATT/WTO and some of the side agreements or Bilateral Investment Treaties. Under broader principles of international law, the territorial integrity of a state can be breached **by** the extraterritorial application of foreign law if there is a specific conflict in the substantive legal norms of the respective states.<sup>63</sup> The extraterritorial application of **US** law thus raises questions under international law if 'there is in fact a true conflict between domestic and foreign law'.<sup>64</sup> It is unclear if there would be a conflict between the anti-fraud provisions of **US** securities law and its European counterparts. The scope of **US** anti-fraud provisions is broader than anti-fraud legislation in European countries, but **it** may be possible to comply with both regimes at the same time. On the other hand, if **US** law requires

**52** To further the goal of the Sarbanes-Oxley Act of mandating disclosure on a rapid and current basis, the **SEC** extended the list of material events that require immediate disclosure **by** listed companies in the United States. See **SEC** Votes to Adopt Additional 8-K Requirements and to Propose Amendments to Form 20-F and Fund Manager Disclosure Requirements, **_SEC_** _News Digest,_ **_I_** 1 Mar. 2004, <www.sec.gov/news/digest/dig031104.txt>. **53** The Committee of European Securities Regulators (CESR) is an independent committee of European Union Member States' securities regulators, but it has no enforcement powers (see <www.cesreu.orglindex.php?page=cesrinshort&mac=0&id=>). 54 Iris H-Y Chiu, 'Delegated Regulatory Administration in Mandatory Disclosure **-** Some Observations from **EU** Securities Regulation', _International Lawyer_ 40 **(2006): 737, 767. 55** **_Supra_** n. 54, 746. **56** Council Directive **2003/6,** Art. **6, 2003 O.J.** (L **96) 16 (EC). 57** Council Directive 2004/109, 2004 **OJ.** (L **390) 38 (EC). 58** Council Directive 2004/39, 2004 **O.J.** (L 145) **1 (EC). 59** Council Directive **2003/71, 2003 OJ.** (L 345) 64 **(EC). 60** Generally on improvement in the Markets in Financial Instruments Directive, see Francois P. Haas,'The Markets in Financial Instruments Directive: Banking on Market and Supervisory Efficiency, IMF Working Papers, <http://ssrn.com/abstract=108716>, **2007,** vol. **1-23. 61** See, for example, Roberta Karmel,'The Case for a European Securities Commission', _Columbia_ **_Journal_** _of Transnational Law_ **38 (1999): 9;** Yannis Avgerinos, 'The Need and the Rationale for a European Securities Regulator, in _Financial Markets in Europe: Towards a Single Regulator,_ ed. Andenas **&** Avgerinos **(2003);** Gilles Thieffry, 'The Case for a European Securities Commission', in _Regulating Financial Services and Markets in the 21st Century,_ ed. Ferran **&** Goodhart (2001); Eric Pan, 'Harmonization of **U.S.-EU** Securities Regulation: The Case for a European Securities Regulator, _Law and Policy in International Business_ 34 **(2003):** 499. **62** Chiu, _supra_ n. 54. **63** See Stfirmer, _supra_ n. **39;** see also Meessen, _supra_ n. **39.** 64 _See Hartford Fire Insurance Co. v. California,_ **509 U.S.** 764 **(1993).**

**JUNE** 2010, **VOLUME 7, ISSUE 3**

**EUROPEAN** COMPANY LAW

**-96 -**

disclosure of information that another country's law would prohibit to be disclosed, whether for privacy reasons or other reasons, there could be a true conflict of law and a credible case that the United States is in breach of international law.

# **4.8.** Diplomacy

**If** section **7216** is enacted, European jurisdictions may feel compelled to change their laws to conform to **US** legal rules. European companies may feel compelled to modify their **US** activities. European governments may take issue with perceived pressure **by** the **US** legal system on their legislatures and regulators. They may also object to their companies being subjected to **US** jurisdiction in securities transactions that have no apparent **US** ties.

The United States does not always have a reputation for cooperation in foreign relations.<sup>6 5</sup> European governments have voiced concern about **US** attitudes towards international law.<sup>66</sup> Section **7216** could be one more impediment to good diplomatic relations if the United States is perceived as establishing its courts as international courts in securities matters with universal jurisdiction.

The **US** government could instead offer to cooperate with the **EU** to prevent securities fraud. The **EU** might in some ways change its law to conform with **US** law and the United States might in some ways change its law to conform with **EU** law. Exporting and imposing rules through extraterritorial reach, on the other hand, could be counterproductive not only for **US** diplomacy but also for international cooperation in combating securities fraud. **If** national securities regulators are unable or unwilling to cooperate with each other, there is likely to be more fraud.

## **5. CONCLUSION**

The decision **by** the Supreme Court in _Morrison v._ **_NAB_** as well as the decision **by** Congress to perhaps enact section **7216** could have a lasting impact on European jurisdictions, companies, lawyers, and investors as well as on foreign trade and diplomacy. European Boards of Directors and company lawyers should follow upcoming events closely and prepare themselves for these impending changes. They should also ask Congress to reconsider section **7216.** Finally, they should ask President Obama to live up to his pledge to improve international cooperation **by** refusing to sign such a provision into law.

> **65** See John R. Bolton,'Is There Really Law in _International Affairs?, Transnational_<sup>_Law_</sup> _and_<sup>_Contemporary Problems_10, no.</sup><sup>**1**(2000):48;see also'SymposiumTranscripts, Toward</sup> an International Criminal _Court?, Emory International Law Review_ 14 (2000): **159** (debating the harmful<sup>effectstoforeign policy inlight of Americanexceptionalism).</sup> **66** See Robert **J.** Delahunty, 'The Battle of Mars and Venus: **Why**<sup>Do AmericanandEuropeanAttitudesTowardInternationalLawDiffer?,</sup><sup>_Loy._</sup><sup>**_U._**</sup><sup>_Chi.Int'lL.Rev.4_</sup> **(2006): 11 (2006).**

**-** **_97_** J **JUNE** 2010, **VOLUME** U **7, ISSUE 3**

**EUROPEAN** COMPANY LAW