In an amicus brief filed with the Second Circuit Court of Appeals, a group of US and German securities law professors urged the appeals court to uphold a district court ruling that global hedge funds managed by US investment managers could not bring a Rule 10b-5 action in US federal court against a German car manufacturer (Porsche) based on securities-based swap agreements referencing the share price of another German car company (VW). A federal judge (SD NY) ruled that a party’s execution in the U.S. of a swap agreement that references foreign securities was not enough to overcome the Supreme Court’s Morrison transactional test for the extraterritorial application of Rule 10b-5. The court said that the swap agreements were the functional equivalent of trading the shares of a German company on a German exchange. Moreover, the swap agreements were transacted with undisclosed counterparties who may well have been located outside the United States. (Elliott Associates v. Porsche Automobil Holding SE, SD NY, 10 Civ. 0532, Dec. 30, 2010).
The law professors asked the appeals court not to allow securities-based swap agreements and other derivative products to be used to arbitrage around the Court’s holding in Morrison and to arbitrage around the law of other countries. Amici urged the appeals court to give issuers and investors in those securities around the world, including parties to security-based swap agreements, clear guidance as to when U.S. securities laws apply to their transactions.
Amici asked the Second Circuit to reject an application of Morrison that turns on the location of the plaintiff or speculation about the location of the counterparties to the swap agreements. Premising a Section 10(b) claim on the location of the plaintiff contradicts the Supreme Court’s holding in Morrison, argued amici, which looks to the location of the transaction, not the location of the plaintiff.
According to the professors, the fact that the underlying security was traded in Germany is a critically important factor in determining the location of the securities-based swaps in this case. The economic fundamentals that determined the value of plaintiffs’ position in the swaps were in the German trading market for VW, and all of the economic fundamentals that defendants allegedly manipulated and misrepresented were in that German market.
To permit this case to proceed would empower the mere presence of U.S. swap parties to serve as a pretext for circumventing Morrison and applying Section 10(b) in circumstances where that statute would not apply. For if the only act complained of concerns the reference security, reasoned amici, any possible counterparty risk located in the U.S. is entirely disconnected from the alleged fraud and as such cannot serve as the basis of a Rule 10b-5 cause of action.
Noting that respect for the securities regulations of other countries was crucial to the Supreme Court’s analysis, the professors emphasized that German law provides adequate civil and criminal remedies against market manipulation and conduct that defrauds investors in security-based swap agreements referencing German securities. Indeed, the statements and transactions by Porsche that are at issue in this case are already being investigated by the German authorities. Section 20a of the German Securities Trading Act, the equivalent of the Securities Exchange Act, prohibits the supplying of false or misleading information of crucial importance to the valuation of financial instruments and deceptive acts influencing their markets or market price.
German courts have not yet decided if there is a private cause of action under Section 20a, similar to Rule 10b-5. Being a civil law jurisdiction German courts are not bound by precedent and can look to law commentaries as well as other court decisions, noted amici, and a significant number of legal writers argue in favor of a private right of action. Also, Section 20a is based on the EU Market Abuse Directive (2003/6/EC) and, although this does not necessarily mean that a private cause of action is required, both the European Commission and European Court of Justice would likely insist that at least that public enforcement reaches a level comparable to that in the United States.
In any event, amici noted that, whether or not there is a private right of action for these hedge funds in Germany, the Morrison decision recognizes that the United States is not the only country capable of regulating securities markets and that Congress did not intend to impose American securities law on the rest of the world. Germany and the other EU member states must decide for themselves the appropriate mix of civil penalties, criminal penalties and private rights of action.