Litigation Consequences of Supreme Court’s Big Decisions

The U.S. Supreme Court has given Corporate America and its lawyers plenty to ponder over the summer, issuing important opinions on securities lawsuits and anti-fraud enforcement that should have a significant effect on litigation in years to come.

First came a decision in Morrison v. National Australia Bank on June 24 that essentially barred “F-cubed” lawsuits—that is, claims by foreign plaintiffs against foreign companies, regarding securities purchased on foreign stock exchanges. That case could have profound implications for overseas groups eager to press their cases in the always-litigious U.S. court system.

Later that same day, the court handed down its ruling in Skilling v. United States, a case brought by disgraced former Enron CEO Jeffrey Skilling. The court sharply narrowed the scope of “honest services fraud”—the legal theory used to convict Skilling and numerous other executives accused of fraud—to say it only applies to outright bribery or kickbacks, not to more subtle schemes executives might use to scam investors.

The two decisions explore very different areas of legal terrain, but of the pair, the Skilling decision is more newsworthy simply because it involves one of the most notorious fraudsters of the 2000s. The court did not exonerate Skilling or overturn his conviction on conspiracy charges, but did send the case back to lower court to see whether the error was harmless and whether potential reversal on the conspiracy count touches any of Skilling’s other convictions.

But based on that ruling in Skilling, the high court did vacate the honest-services fraud convictions of two other men: Conrad Black, former CEO of Hollinger International; and former Alaska state legislator Bruce Weyhrauch. Both cases were remanded to lower courts for further proceedings. Days later, the Supreme Court also ordered the 11th Circuit Court of Appeals to review the bribery and honest-services convictions of former Alabama Gov. Don Siegelman and former HealthSouth CEO Richard Scrushy.

O’Toole

The Skilling decision erases more than 20 years of case law surrounding honest-services fraud. Lawyers expect it will have profound implications for criminal cases involving business executives and public officials charged with fraud, since it applies to all pending cases and to all cases not yet final on direct appeal, says Tim O’Toole a partner in Miller & Chevalier’s litigation practice.

Controversy has dogged honest-services fraud since 1987, when the Supreme Court ruled in McNally v. United States that prosecutors had little room to bring such charges under the mail fraud statute. Congress amended federal law in 1988 to give prosecutors that flexibility they wanted; the law simply says that a “‘scheme or artifice to defraud’ includes a scheme or artifice to deprive another of the intangible right of honest services.” Critics have argued ever since that such language is too expansive and has allowed federal prosecutors to use it as a catch-call to pursue cases against public and private officials for any manner of questionable conduct.

Prior to the Skilling decision, the statute “could be made to fit any sort of conduct that looked bad,” O’Toole says. “Those days are gone.”

They are indeed. In a 6-3 decision written by Justice Ruth Bader Ginsburg, the court held that that honest-services fraud criminalizes only the “bribe and kickback core of the pre-McNally case law.”

The ruling provides “some much needed clarity to the whole area of honest services fraud.”

—Michael Sher,

Partner,

Neal, Gerber & Eisenberg

Skilling was convicted in 2006 on 19 counts of fraud and other securities law violations, including a conspiracy charge brought under the honest-services doctrine; he was sentenced to 292 months in prison. Since his alleged misconduct entailed no bribe or kickback, the Supreme Court vacated the honest services fraud conviction.

Of course, federal prosecutors have many other tools available to charge misconduct, including federal mail and wire fraud, bribery and kickback statutes, the Hobbs Act, the Travel Act, and the Foreign Corrupt Practices Act.

Sher

Michael Sher, a partner in the law firm Neal, Gerber & Eisenberg says the ruling provides “some much needed clarity to the whole area of honest services fraud … We don’t have a perfect answer, but there’s a workable standard,” says Sher.

And the Skilling decision does not resolve all the questions around honest-services fraud. O’Toole says one major issue, which lower courts will need to address, is precisely what constitutes “the bribe and kickback core of pre-McNally case law” that Ginsburg mentioned.

Sher also notes that the ruling doesn’t address a question raised by Justice Antonin Scalia about what constitutes a breach of the “honest services” obligation—namely, whether it must be a breach of federal or state law.

F-Cubed Lawsuits

Meanwhile, corporations might receive some relief from shareholder lawsuits thanks to the Morrison v. National Australia Bank decision. In a unanimous decision, the court ruled that Section 10(b) of the Securities and Exchange Act, which governs shareholder lawsuits, “does not provide a cause of action to foreign plaintiffs suing foreign and American defendants for misconduct in connection with securities traded on foreign exchanges.”

IMPLICATIONS OF MORRISON CASE

The following excerpt from a Davis & Polk news bulletin explains a provision of the Dodd bill in which the U.S. Supreme Court limits extraterritorial application of U.S. securities laws:

Background on the Morrison Case

The defendant National Australia Bank, Ltd. is an Australian bank whose common stock is traded on the Australian Stock Exchange Limited and other non-U.S. securities exchanges. NAB’s American Depositary Receipts are traded on the New York Stock Exchange, but the claims at issue did not involve purchases of ADRs. NAB’s American mortgage service provider subsidiary, HomeSide Lending, Inc., which is headquartered in Florida, allegedly used fraudulent accounting in the United States to overstate the value of its mortgage servicing rights. HomeSide then allegedly sent those inflated figures to NAB in Australia, which disseminated them in public filings. NAB later announced two write-downs totaling $2.2 billion due to recalculations in the value of HomeSide’s mortgage servicing rights. Non-U.S. investors who bought NAB stock on non-U.S. exchanges then sued NAB under antifraud provisions of the U.S. securities laws, principally Section 10(b) of the Exchange Act and SEC Rule 10b-5.

The Second Circuit Court of Appeals, as had long been its practice and the practice in numerous other courts, viewed the issue as one of subject-matter jurisdiction, to be determined based on the extent to which the conduct and effects at issue occurred in or impacted the United States. The Second Circuit upheld the dismissal of the claims for lack of subject-matter jurisdiction based on its conclusion that the heart of the alleged fraud occurred abroad and that the effects were felt abroad.

The Supreme Court’s Decision

The Supreme Court unanimously affirmed the dismissal of the complaint, but did so in a way that changes the prevailing law. A five-member majority of the Court rejected the various formulations of the “conduct” and “effects” tests previously used by most U.S. Circuit Courts of Appeals to analyze whether securities fraud claims could be brought based on securities transactions outside the United States. The Court instead adopted a bright-line transactional test to determine when Section 10(b) is applicable. Specifically, the Court ruled that Section 10(b) and Rule 10b-5 apply “only in connection with a purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Because the case did not involve any trades on a domestic exchange and the purchases occurred outside the United States, the Court held that the petitioners failed to state a claim on which relief could be granted.

The Court found that there is no affirmative indication in the text of the Exchange Act that Section 10(b) was intended to apply extraterritorially, and that absent such an indication the statute does not apply outside the territorial jurisdiction of the United States. Moreover, the Court stated that the focus of the antifraud provisions is not on where the deception at issue originates, but rather on fraud in connection with purchases and sales of securities in the United States. The Court also stressed the importance of avoiding interference with foreign securities regulation.

The Court rejected the test suggested by the Solicitor General—namely, that Section 10(b) is applicable whenever the fraud at issue involves significant conduct in the United States that is material to the fraud’s success. The Court concluded that such a test has no textual support. It further observed that “[w]hile there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on foreign securities markets, some fear that it has become the Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets.”

While the Supreme Court’s ruling does appear to provide bright-line guidance with respect to Section 10(b) and Rule 10b-5 claims, how lower courts apply this decision to various factual scenarios under other provisions of the federal securities laws and even under Section 10(b) and Rule 10b-5 remains to be seen, and we will monitor and report on any noteworthy developments in that regard.

Source

Davis Polk alert on Morrison v NAB (June 24, 2010).

Australian investors had sued NAB in U.S. courts because one of its U.S. subsidiaries, HomeSide Lending, experienced accounting problems that sent NAB’s stock price tumbling. NAB itself, however, does not trade on any U.S. stock exchange. An appeals court in New York had tossed out the shareholders’ lawsuit already, and the U.S. Supreme Court essentially upheld that decision.

The ruling is expected to affect numerous securities class-action lawsuits, including a lawsuit against Vivendi that has already resulted in a jury verdict against the French company for misleading investors about its financial condition in public statements made between 2000 and 2002. In a June 25 press release, Vivendi hailed the Morrison decision, calling it “totally in line with the position defended all along by the Group in the American and French Courts.”

Hervé Pisani, a lawyer for the company, tells Compliance Week via e-mail, “The effect on Vivendi is pretty significant.” As a result of the ruling, Pisani says Vivendi shareholders who didn’t acquire American Depository Receipts in the United States will be excluded from the class—which could be 80 percent of the total class participants, he says.

LaCroix

The ruling could also hit other lawsuits filed in the United States, including one filed against BP in May over the Gulf Coast oil spill, since many of the shareholders in that case purchased their shares in the United Kingdom, says Kevin LaCroix, a director with OakBridge Insurance Services who writes a blog on director and officer liability issues.

While U.S. courts aren’t closed to lawsuits against foreign domiciled claimants, “They are closed to claimants who didn’t buy their shares on a U.S. based security exchange,” he says.

Congress could, however, partially undo some of the Morrison decision, blunting its impact. The Dodd-Frank regulatory reform bill, currently awaiting a final vote in Congress, contains a provision to allow U.S. extra-territorial jurisdiction in securities enforcement actions for the following: “(1) 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; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States."

That language, however, only applies to enforcement actions brought by the Securities and Exchange Commission or some other regulator—not to private lawsuits. As such, it would have no effect on the Morrison plaintiffs, who would still be out of luck.

The House approved the Dodd-Frank bill on June 30. It must still be approved by the Senate and sent to the president for signature.

Other legal developments could also potentially diminish Morrison’s effect. For instance, LaCroix says, plaintiff lawyers could use other legal theories that focus on U.S.-based conduct, such as common law fraud, to bring cases.