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On June 24, 2010, the Supreme Court issued an important decision narrowing the reach of the key antifraud provisions of the Securities Exchange Act of 1934 ("Exchange Act") with respect to the purchase and sale of securities outside the United States. The Court found that the antifraud provisions apply only with respect to (1) the purchase or sale of a security listed on a U.S. stock exchange or (2) the purchase or sale of any other security in the United States.
The Court's decision should be a positive development for non-U.S. issuers because it precludes plaintiffs from bringing federal securities fraud claims with respect to the purchase or sale of their securities on foreign exchanges or otherwise outside the United States. Morrison v. National Australia Bank Ltd., 561 U.S. ___, slip op. No. 08-1191 (June 24, 2010).[1]
Background on the Morrison Case
The defendant National Australia Bank, Ltd. ("NAB") is an Australian bank whose common stock is traded on the Australian Stock Exchange Limited and other non-U.S. securities exchanges. NAB's American Depositary Receipts ("ADRs") are traded on the New York Stock Exchange, but the claims at issue did not involve purchases of ADRs. NAB's American mortgage service provider subsidiary, HomeSide Lending, Inc. ("HomeSide"), which is headquartered in Florida, allegedly used fraudulent accounting in the United States to overstate the value of its mortgage servicing rights. HomeSide then allegedly sent those inflated figures to NAB in Australia, which disseminated them in public filings. NAB later announced two write-downs totaling $2.2 billion due to recalculations in the value of HomeSide's mortgage servicing rights. Non-U.S. investors who bought NAB stock on non-U.S. exchanges then sued NAB under antifraud provisions of the U.S. securities laws, principally Section 10(b) of the Exchange Act and SEC Rule 10b-5.
The Second Circuit Court of Appeals, as had long been its practice and the practice in numerous other courts, viewed the issue as one of subject-matter jurisdiction, to be determined based on the extent to which the conduct and effects at issue occurred in or impacted the United States. The Second Circuit upheld the dismissal of the claims for lack of subject-matter jurisdiction based on its conclusion that the heart of the alleged fraud occurred abroad and that the effects were felt abroad.
The Supreme Court's Decision
The Supreme Court unanimously affirmed the dismissal of the complaint, but did so in a way that changes the prevailing law. A five-member majority of the Court rejected the various formulations of the "conduct" and "effects" tests previously used by most U.S. Circuit Courts of Appeals to analyze whether securities fraud claims could be brought based on securities transactions outside the United States. The Court instead adopted a bright-line transactional test to determine when Section 10(b) is applicable. Specifically, the Court ruled that Section 10(b) and Rule 10b-5 apply "only in connection with a purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States." Because the case did not involve any trades on a domestic exchange and the purchases occurred outside the United States, the Court held that the petitioners failed to state a claim on which relief could be granted.[2]
The Court found that there is no affirmative indication in the text of the Exchange Act that
Section 10(b) was intended to apply extraterritorially, and that absent such an indication the statute does not apply outside the territorial jurisdiction of the United States. Moreover, the Court stated that the focus of the antifraud provisions is not on where the deception at issue originates, but rather on fraud in connection with purchases and sales of securities in the United States. The Court also stressed the importance of avoiding interference with foreign securities regulation.
The Court rejected the test suggested by the Solicitor General—namely, that Section 10(b) is applicable whenever the fraud at issue involves significant conduct in the United States that is material to the fraud's success. The Court concluded that such a test has no textual support. It further observed that "[w]hile there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on foreign securities markets, some fear that it has become the Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets."
While the Supreme Court's ruling does appear to provide bright-line guidance with respect to
Section 10(b) and Rule 10b-5 claims, how lower courts apply this decision to various factual scenarios under other provisions of the federal securities laws and even under Section 10(b) and Rule 10b-5 remains to be seen, and we will monitor and report on any noteworthy developments in that regard.
Potential Legislative Revision—The Dodd-Frank Wall Street Reform and
Consumer Protection Act
Congress, as the Supreme Court itself acknowledges, effectively can overturn the decision in Morrison, in whole or in part, by amending the federal securities laws.
On June 25, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was passed out of Conference. Both chambers aim to present a final bill to the President before July 4th weekend. The bill contains a provision regarding the extraterritorial reach of actions brought by the SEC or the United States under the antifraud provisions of the Exchange Act. Specifically, the proposed law would, if enacted, permit claims by the SEC and other U.S. enforcement agencies with respect to: "(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States." As this provision only affects actions brought by the SEC or the United States, it would have no effect on Morrison with respect to private actions. Additionally, a provision in the bill requires an SEC study on the impact of applying the above test to private actions.
[1] See the Davis Polk Client Memorandum United States Supreme Court to Hear Case Concerning the Extraterritorial Application of U.S. Securities Laws—Morrison v. National Australia Bank dated
December 2, 2009.
[2] The Second Circuit had dismissed the case on the basis of lack of subject-matter jurisdiction. The Supreme Court concluded that the real question was whether the foreign plaintiffs had stated a viable Rule 10b-5 claim, not whether the court had jurisdiction even to consider the case on the merits (which it did).
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