Source: https://www.ktmc.com/news/foreign-investing-post-morrison-vs-national-australia-bank-buyers-be-aware
Timestamp: 2019-04-19 10:17:08+00:00

Document:
Michael D. Herrera is Senior Counsel to the Los Angeles County Employees Retirement Association where he serves as principal legal advisor to the fund’s Board of Retirement, Board of Investments, officers and more than 360 employees. He frequently speaks and writes on various topics related to public pension law, fiduciary duty and investments, and is widely-recognized for his work in the area of securities litigation and corporate governance. He currently also serves on the Executive Board of the National Association of Public Pension Attorneys, and the Advisory Board of the Institutional Investments Forum.
Five years ago, the United States Supreme Court decided a case that garnered little attention outside of legal academia and the securities litigation bar. As it turns out, the Supreme Court’s decision in Morrison v. Nat’l Australia Bank1 has had a far greater reach and, sadly, more devastating impact on U.S. investors than expected. As a result, as Mark Twain keenly observed, investing abroad is indeed a risky endeavor, regardless of the month in which it is done.
In Morrison, the Supreme Court reversed decades of precedent, exposing the foreign investments of U.S. investors to new and unfamiliar risks. Prior to Morrison, defrauded investors could seek to recover foreign investment losses in federal court via the antifraud provisions of the U.S. securities laws, namely, Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”),3 and Rule 10b-5 thereunder,4 provided the wrongdoing occurred within the U.S. (the “Conduct Test”), or had a substantial effect on U.S. markets or citizens (the “Effects Test”). In Morrison, the Supreme Court rejected these tests in favor of a transactional test focusing simply on whether the investor purchased the security in the U.S. As a result, investors who purchase securities outside the U.S. or on a foreign exchange now find themselves stripped of those legal protections long considered fundamental and sound.
Not surprisingly, the fallout from Morrison has been widespread. Courts throughout the country have applied the decision with gusto to dismiss a wide variety of investor claims.5 This has caused defrauded investors to consider other means by which to recover foreign investment losses, such as state and foreign actions, with the latter becoming an increasingly popular option among sophisticated funds.6 This rise in interest and focus on alternative strategies stems from the fact that while a board’s recovery options may have changed, its duty to safeguard fund assets and pursue valid claims has not.
Boards operating and governed under the County Employees Retirement Law of 1937 (the “CERL”)7 have broad discretion with regard to the investments of the fund.8 Indeed, boards must diversify fund investments “so as to minimize the risk of loss and to maximize the rate of return, unless under the circumstances it is clearly prudent not to do so.”9 Taken together, these provisions enable boards to follow “modern portfolio theory”, which essentially provides that no investment is imprudent per se. Rather, all investments, even risky ones, can and must be viewed with an eye toward the portfolio as a whole to determine if they are prudent.
Of course, a board’s discretion is not unfettered. It must discharge its duties “with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with these matters would use in the conduct of an enterprise of a like character and with like aims.”10 Its duty to safeguard fund assets is thus paramount, and manifests in a number of ways including, among other things, the duty to recover monies owing to the fund. This issue typically arises when a fund discovers it has under collected member contributions or overpaid benefits.11 But it can apply equally to the fund’s investment losses.
RECOVERING FUND LOSSES: WHEN THE GOING GETS TOUGH!
Historically, the majority of fraud cases by U.S. investors were brought in federal court under Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which are the principal statutory weapons against fraud available to private investors. Under Morrison, defrauded investors can no longer assert or rely on them to recover losses on securities purchased abroad, even if the alleged wrongdoing occurs entirely within the U.S. The following sections will therefore discuss options still available to defrauded investors, and some of the risks and challenges associated with them.
In Morrison’s aftermath, defrauded investors are increasingly looking to state law claims as a way to recoup foreign investment losses. This is because, while Morrison holds that the Exchange Act lacks extraterritorial application, it says nothing about the continued applicability of state fraud claims to foreign investment losses. From a state’s perspective, it should not matter whether the defendant is a citizen of a different state or country; either way, it is an out-of-state defendant. Investors should therefore still be able to bring state common law and statutory fraud claims, among others, against out-of-state defendants under the laws of the state where the plaintiff resides, or the laws of the state where the defendant(s) committed the wrongful acts.
Of course, there are significant obstacles to pleading state law claims. In particular, common law fraud claims typically do not recognize the fraud-on-the-market presumption of reliance. Plaintiffs must therefore be prepared to plead direct reliance, which can be an onerous task. Also, although many states’ securities fraud statutes include a presumption of reliance or eliminate the requirement altogether, these laws can present their own unique obstacles. For example, many require a direct relationship or connection between plaintiff and defendant. Consequently, while there are exceptions, investors who purchase their shares on the open market may have difficulty satisfying this requirement.
Not long after Morrison was decided, Congress acted with uncharacteristic speed to restore the ability of the U.S. Securities and Exchange Commission (“SEC”) and the U.S. Department of Justice to bring enforcement actions involving transnational fraud under the pre-Morrison Conduct and Effects Tests. Institutional investors, including LACERA and other U.S. public pension funds, urged the SEC to recommend that Congress restore this same right to institutional investors as part of the Commission’s report to Congress as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
Inexplicably, when the SEC issued its report, it did not recommend that Congress extend this right to defrauded U.S. investors. This shortcoming prompted SEC Commissioner Luis Aguilar to issue a scathing letter of dissent to congress in which he warned of the “immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank.” In it, Commissioner Aguilar offers a sobering observation of the harm to be borne by investors as a result of Morrison. He states, “In the United States we have a strong belief that, whether rich or poor, we are all entitled to our day in court. Sadly, for many American investors this is no longer true.” Unfortunately, neither Congress nor the SEC appear ready, willing or able to address Morrison any time soon.
Unless and until something is done to undo or limit Morrison, U.S. investors will continue to look to state and foreign actions as a way to recover foreign investment losses stemming from wrongdoing. Of course, whether or not to pursue such an action is not a decision a pension board can make lightly or in advance. Rather, as a fiduciary, the board must consider the facts, weigh the benefits and risks, and consider its options under the circumstances of a particular case. Accordingly, whether it ultimately makes sense for a fund to pursue such a strategy, having a policy and procedures in place is essential to perform the thoughtful analysis necessary to make a timely, well-informed decision. After all, as all good fiduciaries know, we’re often judged not just by what we decide to do, but how we decide to do it.
1 Morrison v. National Australia Bank Ltd., 561 U.S. 247, 130 S.Ct. 2869 (2010) (“Morrison”).
2 This article is not intended to convey or constitute legal advice, and is not a substitute for obtaining legal advice from your own qualified attorney. You should not act upon any information contained in this article without first seeking qualified professional counsel on your specific matter.
315 U.S.C. § 78a et seq.
4 17 C.F.R. § 240.10b-5.
5 See, e.g., In re Petrobras Sec. Litig., No.1:14-cv-09662(JSR) (S.D.N.Y.); In re BP p.l.c. Sec. Litig., 2012 WL 432611, at *68 (S.D. Tex. Feb. 13, 2012); In re Vivendi Universal, S.A. Sec. Litig., 765 F. Supp. 2d 512, 531 (S.D.N.Y. 2011); In re BP, 2012 WL 432611, at *68; In re UBS, 2011 WL 4059356, at *8.
6 See, e.g., Kevin LaCroix, Plaintiffs’ Lawyers Pursue Non-U.S. Securities Litigation Alternatives After Morrison, The D&O Diary (Jan. 11, 2011).
7 Set forth at Govt. Code § 31450 et seq.
9 Cal. Const., Article XVI, § 17(d); Govt. Code § 31595(c). All references to “§ 17” in this article are to Article XVI, Section 17 of the California Constitution.
10 § 17(c); Govt. Code § 31595(b).
11 See, e.g., City of Oakland v. Oakland Police & Fire Retirement System, 224 Cal.App.4th 210 (2014); In re Retirement Cases, 110 Cal.App.4th 426 (2003); County of Marin. Assn. of Firefighters v. Marin County Employees Retirement Assn., 30 Cal.App.4th 1638 (1994); Barrett v. Stanislaus County Employees Retirement Assn., 189 Cal.App.3d 1593 (1987).
13 See, e.g., Harris v. Koenig, 815 F.Supp.2d 26 (2011) (The duties of loyalty and prudence include the “duty to take reasonable steps to realize on claims held in trust.”). See also Restatement 2nd of Trusts § 177 (“trustee is under a duty to the beneficiary to take reasonable steps to realize on claims which he holds in trust.”).
14 Secretary of Labor’s Memorandum of Law as Amicus Curiae in Support of the Florida State Board of Administration’s Appointment as lead plaintiff in In re Telxon Corp. Sec. Litig., 67 F.Supp.2d 803 (N.D. Ohio, 1999).
15 LACERA has recovered over $66.5 million in securities class action recoveries since first adopting its securities litigation policy in 2001, which includes recoveries obtained through its active involvement and successful prosecution of securities actions, as well as its claims filing efforts.
16 Morrison Four Years Later: Its Impact, Potential Approaches, and Practical Tips, The NAPPA Report (April 2014).
17 Living in a Post-Morrison World: How to Protect Your Assets Against Securities Fraud, The NAPPA Morrison Working Group (June 2012).
18 See Footnote 17, supra.

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