The World in U.S. Courts: Spring 2013 - Securities | March.28.2013
A U.S. District Court in New York refuses to dismiss securities fraud lawsuit against foreign asset manager.
Several hedge funds registered in the Cayman Islands (the “Funds”) sued principals and employees of the company they hired to manage their assets, Absolute Capital Management (“ACM”), which was publicly traded on the London Stock Exchange. They also sued Hunter World Markets (“HVM”), a California brokerage firm with which the Funds did significant trading.
The multifaceted scheme involved penny stocks, which are not traded on a nationally registered exchange, but rather on over-the-counter markets, such as the Over the Counter Bulletin Board and the Pink Sheets. The scheme as alleged operated in this manner: First, ACM would cause the Funds to invest directly into a penny stock company through a transaction called a private investment in public equity (“PIPE”). As a condition of the Funds’ investment, certain individual defendants received shares, options, or warrants from the penny stock company. Second, HVM would then trade these penny stock shares amongst the Funds to artificially inflate the shares’ value. Third, ACM caused the Funds to purchase the penny stock shares from the individual defendants that they received in connection with the PIPE transactions to further drive up prices, often through HVM.
The court observes that a claim under Section 10(b) of the Securities Exchange Act must involve either (1) the purchase and sale of a security listed on a domestic exchange or (2) if the security is not listed on a domestic exchange, then the domestic purchase and sale of that security, i.e. a domestic transaction. To determine the locus of the transaction under the latter category, the court follows the so-called “transaction” test, under which the location of the transaction is where the title is transferred or the parties incurred irrevocable liability.
The district court denied defendants’ motion to dismiss, finding that the transactions at issue were domestic. It found that the initial PIPE transactions were domestic because the related offering memorandum explicitly provided that the Funds incurred irrevocable liability upon delivery of the signed purchase agreement, which occurred in the U.S. It also found that the intra-Fund trading of the penny stocks were domestic transactions for two reasons. First, the court examined each intra-Fund trade as involving two separate contracts for purchase/sale, as each Fund effectively sold the security at issue to HWM, which then sold it to another Fund. Because the contracts thus were with U.S.-based HWM rather than among each other, irrevocable liability occurred in the U.S. Second, the court found that the transfer of title occurred in the U.S. because the trades settled in the U.S.