Monday, April 13, 2015

Payment in Domestic Stocks Saves Foreign Fraud Case from Morrison Dismissal

By Anne Sherry, J.D.

In an allegedly fraudulent stock sale, the plaintiff’s provision of consideration in the form of its own NASDAQ-listed securities was enough of a domestic nexus to overcome the Morrison hurdle, at least in the Ninth Circuit. The court dismissed, with leave to amend, the Exchange Act claims against the defendants for failure to sufficiently plead scienter or to plead fraud with particularity and offered to certify the case for interlocutory appeal, noting a potential circuit split on Morrison’s reach (Motorcar Parts of America, Inc. v. FAPL Holdings Inc., April 8, 2015, Wu, G.).

Background. Motorcar Parts of America, Inc. sued FAPL Holdings Inc. and four of FAPL’s principals for fraud based on the plaintiff’s purchase of capital stock of Fenwick Automotive Products Ltd. (Fenco) and its affiliate and subsidiaries. The plaintiff paid for the Fenco stock with shares of its own common stock, which are listed on NASDAQ.

Morrison argument. The defendants sought to dismiss the Exchange Act claims under an interpretation of the Supreme Court’s Morrison decision that would require, for the U.S. securities laws to apply, that the plaintiff establish that the transaction occurred on a domestic exchange, that title to the security was transferred in the United States, or that irrevocable liability was incurred in the United States. The plaintiff did not attempt to argue either of those scenarios, rather, emphasizing the listing of its own stock on NASDAQ.

Ordinarily, starting from a blank slate, the court would find it a stretch to characterize the transaction at issue as the purchase or sale of the plaintiff’s stock. The language of the purchase agreement leading to all of the plaintiff’s claims defined FAPL as the vendor and the plaintiff as the purchaser, and the transaction was described in terms of the transfer of Fenco shares. But the court explained that the case law directs courts to look at the substance of transactions rather than to their form in determining whether a purchase or sale has occurred.

The defendants also reasoned that if the U.S. securities laws were to apply here, American companies could submit any transaction, anywhere in the world, to the U.S. securities laws by having part of the consideration consist of their domestic stock. But the court estimated that the Supreme Court would likely consider this issue one best left to Congress—especially given that Morrison was “a rumination on Congressional silence” on extraterritoriality of the securities laws.

Second Circuit decisions. Several Second Circuit decisions construing Morrison more narrowly lent credence to the defendants’ argument, but the court ultimately determined that the Morrison test as enunciated reaches “transactions in securities listed on domestic exchanges,” a criterion satisfied in this case. The Ninth Circuit is not bound by the Second Circuit precedent, and none of those circuit’s decisions involved similar facts. Finding that Morrison did not bar the Exchange Act claim, but acknowledging that the outcome may have been different had the case arisen in the Second Circuit, the court expressed a willingness to certify the case for interlocutory appeal.

Dismissal with leave to amend. In the end, the court granted the defendants’ motion to dismiss, but on the basis that the plaintiff failed sufficiently to plead scienter or to plead fraud with particularity. The plaintiff was allowed leave to amend both the Section 10(b) claim and the Section 20(a) claim.

The case is No. 2:14-cv-01153-GW-JEM.

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