Itoba Ltd. v. Lep Group PLC

• Decision Date: 15 May 1995
• Docket Number: D,No. 582,582
• Citation: 54 F.3d 118
• Parties: Fed. Sec. L. Rep. P 98,815 ITOBA LIMITED, Plaintiff-Appellant, v. LEP GROUP PLC, William R. Berkley, John L. Read, Peter J. Grant, John R. East, Defendants-Appellees. ocket 94-7562.
• Court: U.S. Court of Appeals — Second Circuit

Page 118

54 F.3d 118

Fed. Sec. L. Rep. P 98,815

ITOBA LIMITED, Plaintiff-Appellant, v. LEP GROUP PLC, William R. Berkley, John L. Read, Peter J.

Grant, John R. East, Defendants-Appellees.

No. 582, Docket 94-7562.

United States Court of Appeals, Second Circuit.

Argued Dec. 1, 1994.

Decided May 15, 1995.

Mark C. Zauderer, New York City (James Robert Pigott, Jr., Stein, Zauderer, Ellenhorn, Frischer & Sharp, New York City, Richard F. Lawler, James C. Riley, Whitman Breed Abbott & Morgan, Greenwich, CT, of counsel), for plaintiff-appellant.

Jeffrey E. Glen, New York City (Berwin Leighton, New York City, Mark B. Seiger, Halloran & Sage, Hartford, CT, of counsel), for defendant-appellee LEP Group PLC.

William McGuinness, New York City (Fried, Frank, Harris, Shriver & Jacobson, New York City, of counsel), for defendants-appellees William R. Berkley and Peter J. Grant.

Alan H. McLean, Stamford, CT (Neville, Shaver, Kelly & McLean, Stamford, CT, of counsel), for defendant-appellee John R. East.

John L. Read, pro se.

Before: FEINBERG, VAN GRAAFEILAND and MINER, Circuit Judges.

VAN GRAAFEILAND, Circuit Judge:

Itoba Limited appeals from a judgment of the United States District Court for the District of Connecticut (Eginton, J.) dismissing its securities fraud action against Lep Group PLC, William Berkley, John Read, Peter Grant and John East for lack of subject matter jurisdiction. For the reasons stated below, we reverse and remand for further proceedings.

The corporate defendant in this case, Lep Group PLC, is a London-based holding company with some fifty subsidiaries operating in thirty countries. It is a true conglomerate, owning businesses in freight forwarding, home security systems, biotechnology, travel services, and real estate speculation. Lep's "ordinary shares", the British equivalent of common stock, are registered in the United Kingdom, obligating the company to comply with United Kingdom securities laws. The primary trading market for Lep's ordinary shares is the International Stock Exchange of the United Kingdom and the Republic of Ireland Ltd. (the "London Exchange").

To create a United States market for its ordinary shares, Lep deposited 12,842,850 of its approximately 136 million shares in an American depository in 1988. The depository in turn issued an American Depository Receipt (ADR) for each five ordinary shares of Lep on deposit. Because these ADRs trade in the form of American Depository Shares (ADSs) on the National Association of Securities Dealers Automated Quotation System ("NASDAQ"), Lep is subject to the reporting and disclosure requirements of United States securities law.

A.D.T. Limited ("ADT") is a transnational holding company based in Bermuda. Its shares are listed on the New York Stock Exchange and approximately fifty percent of its shareholders of record reside in the United States. Itoba, a Channel Islands company, is a wholly-owned subsidiary of ADT. ADT also is the corporate parent of A.D.T. Securities Systems, Inc., a Delaware-based firm and one of America's largest suppliers of security and protection services.

In mulling over expansion plans for A.D.T. Securities Systems, ADT considered the possible acquisition of one of A.D.T. Securities Systems' largest competitors in the American security market, National Guardian, ADT already owned a small interest in that corporation through shares it held of Lep, the parent company of National Guardian. Because ownership of Lep would lead to control of National Guardian, ADT considered increasing its Lep holdings.

At the same time, Canadian Pacific was interested in expanding into the freight forwarding business and also was pondering a sizeable investment in Lep. Learning of In December 1989, S.G. Warburg issued an extensive report assessing Lep's prospects. The analysis in this report was based on Lep's U.K. annual reports, the Form 20-F that Lep filed with the United States Securities and Exchange Commission for the year ended December 31, 1988, Lep's shareholder register, and broker reports. Shortly after the Warburg report was issued, Canadian Pacific abandoned the proposed joint venture.

their mutual interest, the companies agreed to explore a joint purchase of Lep. Canadian Pacific hired S.G. Warburg, a London investment bank, to evaluate Lep's business operations. Nicholas Wells, ADT's in-house financial analyst, was directed by Michael Ashcroft, ADT's chairman, to perform a valuation of Lep.

ADT's interest, on the other hand, did not diminish. Wells continued his examination of Lep, relying heavily on the Warburg report. To supplement his research, he obtained from Canadian Pacific a copy of Lep's Form 20-F for 1988. Wells frequently discussed his analyses of these documents with David Hammond, ADT's vice chairman and the person in charge of acquisitions.

Based on Wells' analyses and their own review of the Warburg report, Hammond and Ashcroft decided to acquire Lep. Soon thereafter, Hammond formulated a plan to increase ADT's Lep holdings by making anonymous purchases on the market through one of ADT's offshore companies, in this case Itoba. Hammond contacted the board members of Itoba and recommended that they approve his purchase plan.

As expected, Itoba's board approved the plan. Itoba's board then requested one of ADT's employees to commence share purchases in Itoba's name; these purchases were made according to Hammond's plan and paid for by ADT. During the second half of 1990, Itoba executed a number of significant purchases on the London Exchange pursuant to the plan. By November 1990, Itoba had acquired over 37 million Lep ordinary shares for approximately $114 million.

Before ADT could complete its planned acquisition, however, Lep disclosed a series of business reversals that decimated its share value; Lep's stock price plummeted 97% and the value of Itoba's Lep holdings declined by nearly $111 million. Lep wrote off approximately $522 million from its books for the fiscal year ended December 31, 1991.

Itoba sued Lep and its officers in the District of Connecticut, asserting violations of sections 10(b) and 20 of the Securities Exchange Act of 1934 (the "Act") and of Rule 10b-5. According to Itoba, the defendants were subject to liability because they failed to disclose material matters in statements filed with the SEC. Specifically, Itoba alleged that Lep made high risk investments and engaged in speculative business ventures without informing the investing public. Itoba claimed that had these matters been properly disclosed, it would not have purchased Lep's stock at artificially inflated prices.

Itoba also asserted claims against Lep director William Berkley for alleged violations of sections 10(b) and 12(2) of the Act and of Rule 10b-5. Berkley, a United States citizen and a resident of Connecticut, had sold a large block of Lep ordinary shares in the United States on the same day that Itoba purchased a large block of shares in London. Itoba alleged that had Berkley properly complied with his duty to disclose material, nonpublic information before trading, it would not have made that purchase.

Defendants moved to dismiss Itoba's claims for lack of subject matter jurisdiction, and Magistrate Judge Jean Margolis, to whom the matter was referred for recommendation and report, issued a report that recommended dismissing Itoba's action on jurisdictional grounds. The district court adopted the magistrate judge's recommendations in toto. It dismissed Itoba's action on Fed.R.Civ.P. 12(b)(1) grounds in a short-form order. This, we conclude, was error.

It is well recognized that the Securities Exchange Act is silent as to its extraterritorial application. See, e.g., Alfadda v. Fenn, 935 F.2d 475, 478 (2d Cir.) (citing 15 U.S.C. Sec. 78aa), cert. denied, 502 U.S. 1005, 112 S.Ct. 638, 116 L.Ed.2d 656 (1991). However, in determining whether Congress intended that the "precious resources of United States courts" be devoted to a specific transnational securities fraud claim, we are not without guidance. Two jurisdictional tests have emerged under this Court's decisions:

the "conduct test", as announced in Leasco Data Processing Equip. Corp. v. Maxwell, 468 F.2d 1326, 1336-37 (2d Cir.1972), and the "effects test", as announced in Schoenbaum v. Firstbrook, 405 F.2d 200, 206-09 (2d Cir.), rev'd with respect to holding on merits, 405 F.2d 215 (2d Cir.1968) (in banc), cert. denied sub nom. Manley v. Schoenbaum, 395 U.S. 906, 89 S.Ct. 1747, 23 L.Ed.2d 219 (1969). There is no requirement that these two tests be applied separately and distinctly from each other. Indeed, an admixture or combination of the two often gives a better picture of whether there is sufficient United States involvement to justify the exercise of jurisdiction by an American court. It is in this manner that we address the issue of jurisdiction in the instant case. Because we believe that the allegations are sufficient to support jurisdiction, we reverse.

Under the conduct test, a federal court has subject matter jurisdiction if (1) the defendant's activities in the United States were more than "merely preparatory" to a securities fraud conducted elsewhere, Bersch v. Drexel Firestone, Inc., 519 F.2d 974, 987 (2d Cir.), cert. denied, 423 U.S. 1018, 96 S.Ct. 453, 46 L.Ed.2d 389 (1975), and (2) these activities or culpable failures to act within the United States "directly caused" the claimed losses, Alfadda, supra, 935 F.2d at 478. Inherent in the conduct test is the principle that Congress does not want " 'the United States to be used as a base for manufacturing fraudulent security devices for export, even when these are peddled only to foreigners.' " Psimenos v. E.F. Hutton & Co., 722 F.2d 1041, 1045 (2d Cir.1983) (quoting IIT v. Vencap, Ltd., 519 F.2d 1001, 1017 (2d Cir.1975)).

The magistrate judge correctly stated the conduct test when she said that Itoba must prove that Lep's United States-based activities directly caused Itoba's...