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From Securities Regulation Daily, August 15, 2014

Predominance of foreign factors drives dismissal of fraud claim against Porsche

By Lene Powell, J.D.

A three-judge panel of the Second Circuit shot down a claim by a group of hedge funds that Porsche had committed securities fraud by making false statements about its intentions to take over Volkswagen, causing the hedge funds to sustain losses on their swap agreements based on that company’s stock. The panel said that a “domestic transaction in a security” element was necessary but not sufficient to state a properly domestic claim under the Exchange Act, where the claims were predominantly foreign (Parkcentral Global Hub Limited v. Porsche Automobil Holdings SE, et al., August 15, 2014, per curiam).

Porsche’s acquisition of VW shares. From late 2005 through 2007, Porsche Automobil Holding SE (Porsche), a German company, gradually increased its investment in Volkswagen AG (VW), also German, using a strategy centered on call options. Under a German statute known as the “VW Law,” any one VW shareholder’s voting rights was limited to twenty percent of the total voting rights, regardless of how many VW shares the shareholder actually owned. Porsche claimed publicly that it was acquiring the shares to prevent a hostile takeover of VW, with which it had important business relationships. Porsche also said it had no intention of obtaining a controlling interest in VW. By the end of 2007, Porsche had become VW’s largest shareholder, owning thirty-one percent of the company.

Parkcentral Global Hub Limited and more than thirty other international hedge funds used securities-based swap agreements pegged to the price of VW shares, which trade entirely on European stock exchanges, to bet that VW stock would drop. The swaps positions acted like short positions in VW stock, gaining in value if VW stock declined and losing value if the stock rose. In October 2008, Porsche made its true intentions public with a press release titled “Porsche Heads for Domination Agreement,” which revealed that Porsche had acquired 74 percent of VW. The price of VW shares rose dramatically, and for several hours, VW became the most valuable corporation in the world. This caused the hedge funds to suffer large losses on their swaps.

The hedge funds brought a number of actions in the Southern District of New York, arguing that Porsche’s statements were fraudulent; that the funds relied on Porsche’s denial of an intention to take over VW; and that Porsche’s conduct violated U.S. securities laws. The district court consolidated and dismissed the actions, concluding that the swaps were essentially transactions in securities on foreign exchanges, and the Supreme Court’s decision in Morrison v. National Australia Bank Limited (2010) established that Section 10(b) of the Exchange Act has no extraterritorial application.

Morrison and Absolute Activist. The panel explained that Morrison held that in the absence of any indication to the contrary in the Exchange Act, the general presumption against exterritorial effect stood, so Section 10(b) did not apply extraterritorially. Specifically, the Supreme Court stated that Section 10(b) only reaches the use of a manipulative or deceptive device or contrivance “in connection with the 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.”

In Absolute Activist Value Master Fund Ltd. v. Ficeto (2012), the Second Circuit tackled under what circumstances the purchase or sale of a security that is not listed on a domestic exchange should be considered “domestic” within the meaning of Morrison, and concluded that a securities transaction is domestic when (1) the parties incur irrevocable liability to carry out the transaction within the United States or (2) when title passes within the United States. Alternatively, it is sufficient for the plaintiff to allege that title to the shares was transferred within the United States. The identity of the security did not necessarily have any bearing, as the second prong of the Morrison test referred to “domestic transactions in other securities,” not “transactions in domestic securities.”

In the district court, the hedge funds argued that they transacted the securities-based swap agreements in the U.S., and that Section 10(b) applied with equal force to these types of instruments as to the securities themselves. Not so, said Porsche; the relevant factor was that the shares themselves were clearly not covered, so the swaps referencing them were not covered either. The district court took a functional approach to analyzing the swaps, concluding that the economic reality was that the swaps were essentially “transactions conducted upon foreign exchanges and markets,” so were not “domestic transactions” within the protection of Section 10(b).

Domestic transaction in a security. An important question, said the panel, was whether under Morrison, a domestic transaction in a security was not merely a necessary element of a domestic 10(b) claim, but was also sufficient. The panel concluded that no, such a transaction was not alone sufficient to state a properly domestic claim under 10(b). If the domestic execution of the plaintiffs’ agreements could alone suffice to invoke 10(b) liability, then conduct that occurred in a foreign country, concerning securities in a foreign company that traded entirely on foreign exchanges, would be subject to U.S. securities laws. This was a result that Morrison plainly did not contemplate and that the Court’s reasoning did not permit.

The panel determined that it need not decide whether the swaps satisfied the Absolute Activist standard for domestic transactions, because it was clear that the claims were so predominantly foreign as to be impermissibly extraterritorial. If the suit were allowed to proceed, it would allow the plaintiffs, by virtue of an agreement independent of the reference securities, to hale the European participants in the German stocks into U.S. courts and subject them to U.S. securities laws. This had obvious potential for overlap and conflict with foreign regulators’ activity. Although the false statements may have been intended to deceive investors worldwide, the relevant actions were so predominantly German that Section 10(b) could not be invoked in a way consistent with the presumption against extraterritoriality.

Accordingly, the panel ruled that the complaint failed to state a claim for which relief could be granted, and affirmed the dismissal of the complaints. However, the case was remanded to allow the district court grant leave to plaintiffs to file an amended complaint.

The case is No. 11-397-cv(L).

Attorneys: Marc Greenwald (Quinn Emanuel Urquhart & Sullivan LLP) for Parkcentral Global Hub Ltd. Robert J. Giuffra, Jr. (Sullivan & Cromwell LLP) for Porsche Automobil Holdings SE and Porsche AG.

Companies: Parkcentral Global Hub Ltd.; Porsche Automobil Holdings SE; Porsche AG.

MainStory: TopStory Derivatives FraudManipulation Swaps ConnecticutNews NewYorkNews VermontNews

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