Second Circuit Again Limits Extraterritorial Reach of Commodity Exchange Act
November 1, 2022
In Laydon v. Coöperatieve Rabobank U.A., the Second Circuit once again held that the Commodity Exchange Act (CEA) does not apply to futures contracts traded on U.S. exchanges that are tied to the values of foreign commodities. Although the transactions in this case undoubtedly occurred in the United States, the court held that the claims were “predominantly foreign” under Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE because they were based on foreign conduct in foreign markets. The decision in Laydon is consistent with Second Circuit precedent, but it stands in tension with decisions in the First and Ninth Circuits, which have rejected Parkcentral as inconsistent with the Supreme Court’s approach to extraterritoriality.
The plaintiff traded three-month Euroyen TIBOR futures contracts on the Chicago Mercantile Exchange between 2006 and 2011. Euroyen TIBOR (which stands for Tokyo Interbank Offered Rate) represents the rate at which banks can lend Japanese Yen outside Japan, calculated by the Japanese Bankers Association based on submissions from banks in Tokyo. It is affected by another benchmark rate for lending Yen outside Japan, Yen LIBOR (which stands for London Interbank Offered Rate), which was calculated by the British Bankers Association (BBA) based on submissions from banks in London.
In 2012, it came to light that banks had manipulated LIBOR to favor their own trading positions by giving false submissions to the BBA. The plaintiff brought a putative class action against more than twenty such banks and brokers, alleging that their false submissions had affected the value of the Euroyen TIBOR futures in which he traded. The question in Laydon was whether the CEA’s private right of action extended to the defendants’ activities abroad.
In Morrison v. National Australia Bank (2010), the Supreme Court adopted a two-step approach to the presumption against extraterritoriality, a federal canon of statutory interpretation, which the Court later restated in RJR Nabisco v. European Community (2016). At step one, a court looks for a clear indication of a provision’s geographic scope. If it finds no clear indication, then at step two, the court considers whether the provision’s application in the current case should be considered “domestic” based on the “focus” of the provision.
In Morrison, the Court applied this approach to Section 10(b) of the Securities Exchange Act, which prohibits securities fraud. At step one, the Court found no clear indication that the provision applies extraterritorially. Turning to step two, the Court determined that the focus of Section 10(b) was the transaction in securities rather than the alleged fraud. It therefore adopted a “transactional test,” holding that Section 10(b) applies to transactions in securities that occur in the United States. The Second Circuit soon clarified in the Absolute Activist case that if the transaction occurs in the United States, there is no additional requirement of fraudulent conduct in the United States.
In Parkcentral, however, the Second Circuit held that a domestic transaction, without more, may not be enough for Section 10(b) to apply. In that case, the Second Circuit was faced with securities-based swap agreements that were entered in the United States but referenced securities in a foreign company that were traded on a foreign stock exchange. The court assumed that the swap agreements met Morrison’s transactional test for domestic application because they were entered in the United States. Nevertheless, it held that this domestic transaction alone was not sufficient for Section 10(b) to apply. When the defendants did not participate in the U.S. transactions and the claims were based on foreign statements about a foreign company whose stock was traded on foreign exchanges, the court concluded, the claims must be considered “so predominantly foreign as to be impermissibly extraterritorial.”
Commodity Exchange Act
Futures contracts in commodities are governed not by the Securities Exchange Act but rather by the Commodity Exchange Act. In construing the CEA’s private right of action, the Second Circuit has adopted Morrison’s transactional test.
In Prime International Trading, Ltd. v. BP P.L.C., however, the Second Circuit extended Parkcentral’s “predominantly foreign” test to claims under the CEA. The plaintiffs in that case had traded futures pegged to the price of Brent crude on the New York Mercantile Exchange. Brent crude is oil extracted from the North Sea in Europe, the price of which serves as a benchmark for two-thirds of the world’s internationally traded crude. The defendants allegedly engaged in fraudulent transactions to manipulate the price of Brent crude in a way that would favor their own trading positions. Because the claims involved alleged misconduct abroad in connection with a commodity that was traded abroad, the court concluded that the claims were “predominantly foreign”—and therefore impermissibly extraterritorial—despite the existence of transactions in the United States.
Laydon simply applies Parkcentral to a different kind of futures contract tied to a different kind of benchmark—the interest rate for Yen rather than the market price of crude. In Laydon, as in Prime International Trading, the Second Circuit found the claims to be predominantly foreign because they were based on foreign conduct manipulating a foreign market for a foreign asset.
Other circuits have declined to follow Parkcentral in cases brought under Section 10(b) of the Securities Exchange Act. Stoyas v. Toshiba Corp. involved purchases of American Depository Receipts (ADRs) in the United States, tied to the value of a Japanese company traded on the Tokyo Stock Exchange. The defendant argued that the claims should be rejected as “predominantly foreign” under Parkcentral, but the Ninth Circuit rejected that approach as “contrary to Section 10(b) and Morrison itself.”
The court emphasized that Section 10(b)’s text refers to the “purchase or sale of any security registered on a national securities exchange or any security not so registered.” The court also noted that Parkcentral’s carve-out for predominantly foreign claims was based on speculation about congressional intent, of which Morrison disapproved, and replaced its clear rule for the application of Section 10(b) with “an open-ended, under-defined multi-factor test, akin to the vague and unpredictable tests that Morrison criticized.” Finally the court noted that Parkcentral’s test relied heavily on the location of the deceptive conduct, which Morrison held to be irrelevant.
In SEC v. Morrone, the First Circuit similarly rejected Parkcentral as “inconsistent with Morrison.” “The existence of a domestic transaction suffices to apply the federal securities laws under Morrison,” the court held. “No further inquiry is required.”
Neither the First nor the Ninth Circuit has yet considered Parkcentral for claims brought under the CEA (nor has any other circuit, for that matter). But it is hard to see either court adopting Parkcentral’s approach for commodities fraud claims after their decisive rejections of that approach for securities fraud claims.
It is easy to sympathize with the Second Circuit’s concerns in Parkcentral, Prime International Trading, and Laydon. In each of those cases, plaintiffs sought to subject foreign defendants to liability under U.S. law by entering transactions in the United States in which the defendants had no part. Of course, the same was arguably true in Stoyas, where at least some of the claims involved ADRs that the defendant Toshiba had no hand in creating.
Moreover, it should hardly come as a surprise to multinational companies, like Toshiba and Porsche, or to participants in international markets, like those for currency and oil, that billions of dollars in derivatives are linked to the securities and commodities in which they deal. It rings hollow for such defendants to protest, like Captain Renard in Casablanca, that they are “shocked” to find that their fraud or market manipulation has caused losses for transactions among other parties.
The Supreme Court denied cert in Stoyas, despite the circuit split. And it denied cert in Prime International Trading, despite the Second Circuit’s decision to extend Parkcentral’s reach. But sooner or later, whether in a CEA case like Laydon or in another Section 10(b) case, the Supreme Court will have to address Parkcentralhead on. It will have to decide whether Morrison’s transactional test should be supplemented by a supplementary case-by-case analysis of extraterritoriality or whether Morrison’s bright-line test should be exclusive.