Cross Border Shareholder Class Actions Before and After Morrison

Elaine Buckberg is Senior Vice President at NERA Economic Consulting. This post is based on a NERA publication by Ms. Buckberg and Max Gulker; the full publication is available here.

In our paper, Cross Border Shareholder Class Actions Before and After Morrison, we conduct an empirical inquiry into the effect of the Supreme Court’s 2010 decision in Morrison v. National Australia Bank on the competitiveness of US markets as a venue for listings by foreign issuers and trading in cross-listed stocks. Passed in the wake of Morrison, the Dodd-Frank Act requires that the SEC inform Congress about the merits of creating a new extraterritorial private right of action. We provide input into the debate by using data on 329 shareholder class actions filed against foreign companies and discussing the effects of such a right on the competitiveness of U.S. capital markets.

We conclude that foreign companies’ expected litigation costs should fall after Morrison, because investors who purchased their shares on overseas exchanges will be excluded from classes. By reducing expected litigation costs, Morrison eases a deterrent to US listing by foreign issuers and thereby makes the US a more competitive venue for cross-listings, as well as for the volume in the cross-listed stocks. We submitted our paper to the SEC as part of its public comment process, and have posted it on SSRN.

In June 2010, the Supreme Court ruled in Morrison that only trades on US markets are covered under the Securities Exchange Act of 1934, significantly limiting the extraterritorial scope of Section 10(b) of the Act. Prior to Morrison, US courts generally allowed shareholders to participate in a class if they were either US residents, or purchased on a US market. Courts decided whether to allow so-called “F-cubed” or “F3” investors (foreign investors purchasing shares of a foreign company on a foreign market) on a case-by-case basis. Morrison rose to a Supreme Court appeal in part because, by the Second Circuit appeal, all three lead plaintiffs were F3 investors.

Plaintiffs and their attorneys have commonly filed class actions against non-US companies in US courts, due to factors including the well-defined legal framework for class actions, the allowance for contingency fee arrangements, and the absence of fee shifting rules. From 1996 through 2011, foreign companies accounted for an average of 11.4% of shareholder class action filings. While this share is below the 13.2% of US listings by foreign firms during the same period, foreign firms have certainly not been immune to US class action litigation. As shown in Figure 1 below, 43% of these filings were against companies that listed shares both in the US and on foreign exchanges (as opposed to listing only in the US). Furthermore, 73% of filings against dual-listed defendants sought to include F3 investors in the class.

Prior to the Supreme Court’s decision in Morrison, courts could decide whether to exclude F3 investors at both the motion to dismiss (based on a claim of lack of subject matter jurisdiction) and the class certification stages of the litigation. The courts had articulated two tests, the conduct test and the effect tests, to determine subject matter jurisdiction. Courts typically ruled that investors living in the US or purchasing on US markets satisfied the “effects test,” first articulated in Schoenbaum v. Firstbrook (1968). F3 investors did not satisfy the effects test, and were instead subject to the “conduct test,” first articulated in Leasco v. Maxwell. While different courts have produced different interpretations of the conduct test, the essential question is whether some component of the alleged fraudulent conduct took place within the US.

Before Morrison, courts ruled on subject matter jurisdiction in 41 cases, allowing F3 investors to remain in the class 27 times (66%), dismissing F3 investors 12 times (29%), and partially dismissing F3 investors twice. Courts were more likely to find subject matter jurisdiction for F3 investors in cases involving Canadian defendant firms, as compared to European defendant firms, as shown in Figure 2 below.

F3 investors faced a second hurdle at the class certification stage, where courts sometimes dismissed some or all F3 investors due to concerns that courts in their home country would not recognize a US decision. In 38 pre-Morrison rulings on class certification, a class including F3 investors was certified 23 times (61%), not certified 14 times (37%) and partially certified once. Again, courts were more likely to certify a class containing F3 investors in cases involving Canadian defendant firms, as show in Figure 3 below.

Morrison slashes the expected litigation exposure of any foreign issuer whose stock trades in the US to the percentage of its shares purchased in the US, by excluding from classes those investors who purchased their shares overseas. Using NERA’s Securities Class Action Database, we estimate that, prior to Morrison, foreign companies listed in the US faced an expected annual average class action litigation settlement cost of approximately $940,000. By reducing expected litigation costs, including the associated costs of Directors and Officers insurance, Morrison improves the attractiveness of cross-listing in the US and therefore improves US competitiveness in attracting new listings.

Morrison creates incentives for investors to execute their purchases in the US, precisely in order to be eligible to participate in shareholder class actions and be compensated via settlement distributions or damage awards. Court decisions have already excluded from classes purchases made by US investors but executed outside the US. [1] Academic research on where cross-listed stocks trade indicates that the demand for US execution is elastic and affected by the relative strength of investor protections in the US versus the home market. [2] Going forward, at least some institutional investors are likely to request that their trades in cross-listed stocks be executed in the US, or at least discuss the relative merits of execution in the US versus other markets. As a result, we are likely to see some volume in cross-listed stocks shift to the US.

The competitiveness gains for US listings and US trading execution are, however, offsetting. Increases in the US share of trading volume in cross-listed stocks will mitigate the expected litigation cost savings from Morrison.

The full publication is available here.


[1] See Plumbers’ Local Union No. 12 Pension Fund v. Swiss Reinsurance Co., 753 F. Supp. 2d 166 (S.D.N.Y. 2010) and Sgalambo v. McKenzie, 739 F. Supp. 2d 453 (S.D.N.Y. 2010).
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[2] Halling et al., “Where is the Market? Evidence from Cross-listings in the United States,” Review of Financial Studies, 2008.
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