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Insights on M&A, litigation, and corporate governance in the US.

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Second Circuit Decision Reiterates That US Securities Laws Do Not Apply To “Predominantly Foreign” Transactions

Cavello Bay Reinsurance Ltd. v. Stein, 2021 WL 232551
(2d Cir. Jan. 25, 2021)

On January 25, 2021, the United States Court of Appeals for the Second Circuit (the Second Circuit) held that a private contract for the sale of securities from one Bermudan entity to another fell outside the territorial scope of the U.S. securities laws, even where the transaction was partially executed in the United States.  The Second Circuit’s decision in Cavello Bay Reinsurance Ltd. v. Stein[1] reaffirms the court’s previous holding in Parkcentral Global HUB Ltd. v. Porsche Automobile Holdings SE[2] that claims based on securities transactions executed within the United States are nevertheless outside the territorial scope of U.S. securities laws if they are “predominantly foreign.”  The Second Circuit’s decision is important both because it solidifies an already existing circuit split with the United States Court of Appeals for the Ninth Circuit (the Ninth Circuit) in light of the Ninth Circuit’s holding in Stoyas v. Toshiba Corp.,[3] and because it provides some guidance as to what might render a securities transaction “predominantly foreign,” and thus outside the reach of the U.S. securities laws.

Background and District Court’s Decision

In a private offering, Cavello Bay Reinsurance Ltd. (Cavello Bay), a Bermudan corporation, bought shares in Spencer Capital Ltd. (Spencer Capital), a private holding company organized under Bermudan law with its principal place of business in New York.[4]  The transaction was marketed in New York, and Cavello Bay’s purchase was executed through a purchase agreement that Spencer Capital sent from New York to Cavello Bay, and which Spencer Capital’s CEO ultimately signed in New York.[5]  The subscription agreement stated that the shares issued by Spencer Capital were “restricted” such that Cavello Bay would need to register them with the U.S. Securities and Exchange Commission (the SEC) before it could resell them.[6]

Cavello Bay filed suit in the United States District Court for the Southern District of New York (the District Court), asserting that Spencer Capital’s misrepresentation concerning the fees that it would pay to its portfolio manager violated the antifraud provisions of Section 10(b) of the U.S. Securities Exchange Act (respectively, Section 10(b) and the Exchange Act).[7]

Spencer Capital sought to dismiss the complaint.  It argued that the transaction was outside the territorial reach of Section 10(b) because (i) the transaction was partially executed outside the United States, and so was not a “domestic” transaction in securities under controlling precedent, and (ii) even if it was, the transaction was “so predominantly foreign” as to fall outside the reach of U.S. securities laws.  The District Court agreed with Spencer Capital on both grounds and dismissed Cavello Bay’s complaint for failure to allege a transaction within the territorial scope of Section 10(b).[8]

The Ever-Evolving Reach of U.S. Securities Laws

In Morrison v. National Australia Bank, Ltd., the U.S. Supreme Court addressed the territorial reach of the U.S. securities laws.[9]  The Court held that Section 10(b) applies only to (1) transactions in securities listed on domestic U.S. exchanges, and (2) domestic (i.e., U.S.) transactions in other securities.[10]  The Supreme Court has stated that, under this test, “the focus . . . is not upon the place where the deception originated, but upon purchases and sales of securities in the United States.”[11]

Interpreting Morrison, the Second Circuit held that an over-the-counter securities transaction is “domestic” where the plaintiff plausibly alleges “that the purchaser incurred irrevocable liability within the United States to take and pay for a security, or that the seller incurred irrevocable liability within the United States to deliver a security.”[12]  Subsequently, the Second Circuit held that the act of incurring irrevocable liability in the United States, by itself, will not bring a securities transaction within the territorial scope of Section 10(b) when the alleged fraud is based on conduct that is “so predominantly foreign as to be impermissibly extraterritorial.”[13]

Four years later, the Ninth Circuit adopted the Second Circuit’s “irrevocable liability” test to determine whether a securities transaction is “domestic” for purposes of Morrison’s territoriality test.[14]  However, the Ninth Circuit disagreed with the Second Circuit and held that incurring irrevocable liability in the U.S. is, standing alone, sufficient to satisfy Section 10(b)’s territorial limitations, even in the case of a “predominantly foreign” claim.[15]  In the Ninth Circuit’s view, the “predominantly foreign” test established by the Second Circuit improperly focused on the locus of the alleged deception, contrary to what it viewed as the Supreme Court’s instruction in Morrison that U.S. securities laws should focus on purchases and sales of securities in the United States.[16]

The Second Circuit’s Decision

As a threshold matter, the Second Circuit declined to consider whether the securities transaction in question was a “domestic” transaction.  The Second Circuit noted that because the transaction was executed by the seller in the United States, and by the buyer outside the United States, the “place of the transaction is difficult to locate.”[17]  Nevertheless, the Second Circuit concluded that even if Cavello Bay had alleged a “domestic” transaction, its claim was so predominantly foreign as to pass beyond the permissible territorial scope of Section 10(b).[18]

In the Second Circuit’s view, two points should guide an extraterritoriality analysis.  First, “Morrison’s domestic transaction rule operates as a threshold requirement, and as such may be underinclusive.”[19] According to the Second Circuit, a domestic securities transaction is necessary, but not necessarily sufficient, to bring the transaction within the territorial scope of Section 10(b). Second, the “predominantly foreign” analysis should “focus on the transaction rather than the surrounding circumstances,” (a distinction addressed in more detail below) and “consider whether a claim—in view of the security and the transaction as structured—is still predominantly foreign.”[20]

Applying this guidance, the Second Circuit found it significant that Cavello Bay’s claims were based on a private agreement for a private offering between a Bermudan investor and a Bermudan issuer.[21]  The main link between the shares and the U.S.—a clause in the subscription agreement restricting Cavello Bay from reselling the shares unless it first registered them with the SEC—was designed to “avoid[] regulation by the United States” that might otherwise apply without such a restriction on resale.  Because the “transaction implicate[d] only interests of two [non-US] companies and Bermuda,” and not “any U.S. interest or other interest that [Section10(b)] is meant to protect,” the transaction fell outside the territorial scope of Section 10(b).[22]

Finally, the Second Circuit expressly rejected Cavello Bay’s contention that the following alleged facts created a transaction within Section 10(b)’s territorial scope:  that Spencer Capital made the misstatement from New York, planned to use the funds to invest in a U.S. insurance service, had its principal place of business and CEO and directors in New York, and was managed by a U.S. company.[23]  In the Second Circuit’s view, “this [wa]s not enough,” because the “contacts that matter are those that relate to the purchase and sale of securities.”[24]


The Second Circuit’s decision has important implications.

First, the Second Circuit instructed that the primary criteria for determining whether a Section 10(b) claim is “predominantly foreign” are “the security and the transaction as structured,” and not the “surrounding circumstances” of the transaction or alleged fraud.  For example, the most important factors in the Second Circuit’s analysis was that the two non-US parties to the share purchase structured the transaction “in a way that avoids regulation by the Unites States,” including “the bother and expense (and taxation) of U.S. law.”[25]  With no U.S. investors to protect, and without the potential for a U.S. court decision “to enhance confidence in the U.S. securities markets,” there was no reason to provide Cavello Bay with a U.S. forum for its lawsuit.[26]  The Second Circuit deemed it irrelevant that certain aspects of contract formation took place in, and that the alleged misstatements emanated from, New York.  The Second Circuit’s focus on the structure of a transaction, which may be more predictable than the contacts that a transaction may have with the U.S., provides sophisticated market participants with at least some additional guidance on how to structure their transactions to benefit from, or avoid, the reach of U.S. securities laws.

Second, the Second Circuit reaffirmed the validity of its “so predominantly foreign” test.  In doing so, the court solidified a split with the Ninth Circuit.[27]  Under Ninth Circuit precedent, incurring irrevocable liability in the U.S., standing alone, will bring a claim based on that transaction within the geographic reach of the U.S. securities law.  By contrast, courts in the Second Circuit may examine other aspects of a securities transaction—including the structure of the transaction, and whether applying U.S. laws might protect U.S. investors—to determine that the transaction is impermissibly extraterritorial, even where irrevocable liability occurs in the U.S.  Therefore, at least for the near term, a difference will remain amongst courts in the Second and Ninth Circuits over the extent to which the U.S. contacts of litigants or third-parties can create a “domestic transaction” within the scope of the Exchange Act.  This difference will make it more difficult for non-U.S. issuers to predict whether U.S. securities laws might apply to claims based on their securities transactions, even if the non-U.S. issuers structure their transactions in accordance with the guidance provided by the Second Circuit in Cavello Bay.


[1]             2021 WL 232551 (2d Cir. Jan. 25, 2021).

[2]             763 F.3d 198 (2d Cir. 2014).

[3]             896 F.3d 933 (9th Cir. 2018).  Our prior analyses of the Toshiba case can be found here and here.

[4]             Cavello Bay, 2021 WL 323551, at *1.

[5]             Id. at *2-3.

[6]             Id. at *2.

[7]             Id.

[8]             Id. at *2.

[9]             561 U.S. 247 (2010).

[10]            Id. at 266-67.

[11]            Id. at 266.

[12]            Absolute Activist Value Master Fund Ltd v. Ficeto, 677 F.3d 60, 67 (2d Cir. 2012).

[13]            Parkcentral Global Hub v. Porsche Automobile Holdings, S.E., 763 F.3d 198, 216 (2d Cir. 2014).

[14]            Toshiba, 896 F.3d at 949.

[15]   950.

[16]            Id. 

[17]            Cavello Bay, 2021 WL 232551, at *2.

[18]            Id. at *3.

[19]            Id. at *4. 

[20]            Id.

[21]            Id.

[22]            Id.

[23]            Id. 

[24]            Id.

[25]            Id.

[26]            Id.

[27]            See Stoyas v. Toshiba Corp., 896 F.3d 933, 950 (9th Cir. 2018).