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Foreign Investing Post Morrison vs. National Australia Bank: Buyers Be Aware!

November 6, 2015

(Reprint courtesy of the State Association of County Retirement Systems (SACRS)

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.

“ October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”

   - Mark Twain

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.

Questions having to do with how and where pension fund trustees choose to invest fund assets are best put to their investment professionals. But as another famous American, Benjamin Franklin, famously observed, “an investment in knowledge always pays the best interest.” This article will therefore discuss the legal challenges and risks U.S. investors continue to face in connection with recovering foreign investment losses stemming from wrongdoing post Morrison, options pension funds and other institutional investors are considering to limit the risk, and, finally, the status of efforts to undo or limit its impact.2


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.

An investment loss stemming from wrongdoing can give rise to a claim to recover monies owing to the fund since it is, after all, an asset of the fund.12 As with overpaid benefits and underpaid contributions, a board must therefore make every reasonable effort to pursue a valid claim.13 The United States Department of Labor affirmed this principle more than a decade ago in the context of securities litigation when it stated that “not only is a fiduciary not prohibited from serving as lead plaintiff [in a federal securities class action], the Secretary believes that a fiduciary has an affirmative duty to determine whether it would be in the interest of the plan participants to do so.”14 [Emphasis added.]

Thus, a board charged with safeguarding fund assets is not required to blindly file or join a securities action in which it may have an interest, but to identify and make an informed decision as to whether it would be in the fund’s best overall interest to do so. In 2011, for example, the Los Angeles County Employees Retirement Association (“LACERA”) revised its longstanding securities litigation policy in the wake of Morrison to ensure its continued ability to identify, evaluate and monitor securities actions in which the fund has an interest, both within the U.S. and abroad, and to pursue claims when and in a manner the board determines is in the overall best interest of the fund.15 Funds throughout the country have adopted similar “global” policies to ensure the best interests of those funds are similarly protected.16


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.


Where state law claims (or other non-federal securities claims) are not a viable option, the only available option to recover losses on foreign investments post Morrison may be to bring suit outside the U.S. While most of the world’s securities class actions and settlements currently occur in the U.S., the global expansion of investor actions continues. Canada, Australia, and several European countries have become new hotspots for securities litigation, with Asian countries beginning to implement similar systems. Mexico began allowing class actions for the first time in 2012.17 As a result, involvement in foreign actions is becoming an increasingly popular option among sophisticated investors, including many public pension funds. Of course, investors will face significant hurdles when pursuing claims in foreign jurisdictions. For example, foreign jurisdictions generally do not allow the type of contingency fee arrangements commonly employed in the U.S. As a result, cases are funded by professional, third party “litigation funders” who finance the case, hire counsel, and take on the risk of loss if the case is not successful. In return, they earn a percentage of the recovery if the case is successful, much like contingency fee arrangements in the U.S., but at percentages typically much higher. Most foreign jurisdictions also employ what’s called a “loser pay” requirement wherein the losing party can be required, subject to court approval, to compensate the prevailing party for their costs and attorneys’ fees in connection with the action. Moreover, unlike in the U.S. where defrauded investors can remain passive members of a class action and receive their pro rata share of the recovery simply by submitting a timely claim, most foreign jurisdictions require that investors “opt-in” to the action in order to participate and share in the recovery. This “opt-in” process requires action early in the process, and can involve the payment of a registration or subscription fee. Not surprisingly, funds that have adopted “global” policies like LACERA and the Massachusetts Pension Reserves Investment Board, for example, utilize dedicated outside counsel and/or a third party monitoring service to assist in identifying and evaluating potential foreign actions.18


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.

8 See Govt. Code § 31594 (“It is the intent of the Legislature ... to allow the board of any retirement system ... to invest in any form or type of investment deemed prudent by the board pursuant to the requirements of Section 31595 ... This will increase the flexibility and range of investment choices available to these retirement systems, while ensuring protection of the interest of their beneficiaries.”)

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).

12 § 17(a) (“The assets of a public pension or retirement system are trust funds and shall be held for the exclusive purposes of providing benefits to participants in the pension or retirement system and their beneficiaries and defraying reasonable expenses of administering the system.”)

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.