Absolute Activitist Decision Delineates Extraterritorial Reach of U.S. Securities Law

In 2010, the Supreme Court addressed whether the securities laws apply extra-territorially to transactions in foreign securities of foreign issuers by foreign investors. In what are known as the “F-Cubed” cases, the court held that the anti-fraud provisions of the Securities and Exchange Act of 1934 did not apply to the foregoing types of transactions but only to “domestic transactions” which it defined to be “transactions in securities listed on U.S. Exchanges” and “domestic transactions in other securities”.  Further guidance as to what constitutes a “domestic transaction” was not provided by the court.

The Second Circuit’s recent Absolute Activist Value Master Fund Ltd v. Ficeto decision clarifies the boundaries of what should be considered a “domestic transaction”. Absolute arose out of an alleged “pump and dump” scheme where nine Cayman hedge funds alleged Absolute Capital induced them to directly invest in small offerings by U.S. issuers at inflated prices before such entities went public. As investment manager of the Fund, Absolute traded the securities of these issuers after they went public generating significant commissions and trading profits for itself in the process. Eventually, however, the price of these issuers’ securities crashed and the Cayman funds were left with substantial losses.

Although the all issuers were U.S. domiciled entities, the securities were purchased directly and not on exchanges and therefore the court concluded that the Plaintiffs had not adequately alleged that the transactions were “domestic” for purposes of the securities laws and therefore the case should be dismissed. On appeal, the Second Circuit affirmed the lower court’s decision finding that no “domestic transaction” had been alleged. For a purchase or sale giving rise to a federal securities law claim to have occurred either of the following two conditions must have : (i) a trader incurs irrevocable liability within the U.S. to produce or deliver a security, or (ii) when title to a security is transferred in the U.S.