It is not easy to plead a viable federal securities fraud claim, what with the requirements of the Private Securities Litigation Reform Act, the Supreme Court’s tightening of Rule 8 pleading standards, and the ever more muscular application of the particularity requirements of Rule 9(b).  Now Judge Baer has further upped the ante in Elliott Associates LLC v. Porsche Automobil Holding SE, 10 Civ. 0532 (S.D.N.Y.) by dismissing Rule 10b-5 claims brought by US hedge funds on the ground that the claims do not arise from “domestic transactions,” as articulated by the Supreme Court in last term’s opinion in Morrison v. Australia National Bank (majority opinion here).

The Plaintiff hedge funds allleged they were defrauded by Porsche’s false public denials of its intent to acquire the stock of Volkswagen (VW).  Porsche, according to the hedge funds, secretly accreted VW shares despite its public denials, and the price of VW shares skyrocketed when Porsche’s acquisition was revealed. The swaps operated as short sales, meaning their value dropped like a rock, and the hedge funds claimed losses of more than $2 billion.

In Morrison, the Supreme Court limited the application of section 10(b) to “transactions in securities listed on domestic exchanges, and domestic transactions in other securities.”  Securities swap agreements are “privately negotiated contracts that are not traded on any exchanges.”  Thus, the question for Judge Baer was whether the swaps were “domestic transactions?” 

Porsche is a German company, as is non-party VW.  But, Plaintiffs alleged that investment decisions were made by the US-based investment managers, that the swaps were confirmed in the US, and that their swap agreements contained US forum selection and choice of law clauses.  Defendants argued that Morrison should bar a claim based on the swaps because Plaintiffs “effectively transacted on a foreign exchange when they took short positions through swaps referencing VW shares.”

Defendants have the better argument, according to Judge Baer, because the “economic reality” is that the swaps are “the functional equivalent of trading the underlying VW shares on a German exchange… [and] I am loathe to create a rule that would make foreign issuers with little relationship to the U.S. subject to suits here simply because a private party in this country entered into a derivatives contract that references the foreign issuer’s stock.” 

Judge Baer also dismissed the pendent state law claims, giving some deference to a letter from the German Consulate in New York advising of ongoing investigations by German securities regulators into Porsche’s accumulation of VW shares.  So maybe the hedge funds do have a real securities fraud gripe, but it’s not one that can be resolved in the federal courthouse.