June 24, 2010
In a landmark decision on the extraterritorial application of the United States securities laws, the Supreme Court held today that plaintiffs who purchase securities on foreign exchanges cannot bring a federal securities fraud lawsuit under Section 10(b) of the Securities Exchange Act and SEC Rule 10b-5, promulgated thereunder. See Morrison v. National Australia Bank, 561 U.S. ___, Slip Op. at 24 (June 24, 2010).
In a decision authored by Justice Antonin Scalia, the Court held that "Section 10(b) reaches the use of a manipulative or deceptive device or contrivance only in connection with the 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," even if fraudulent conduct allegedly occurred in the United States. Id. at 17, 24. The Court’s ruling has significant implications for issuers whose stock is traded on foreign exchanges, as it eliminates so-called "f-cubed" litigation–i.e., securities fraud suits on behalf of foreign purchasers of a foreign company’s shares on a foreign exchange.
The Court’s holding affirmed the result but not the reasoning of the Second Circuit, which had used a "conduct and effects" test to discern whether Congress "would have intended" Section 10(b) to have extraterritorial reach even though the statute is silent on the subject. The Court criticized this and similar tests applied by other circuits as "unpredictable in application" and contrary to the familiar presumption against extraterritorial application of congressional statutes absent a clear indication of extraterritorial reach. Instead, the Court unambiguously concluded that Section 10(b) and Rule 10b-5 do not apply to foreign purchases because there is no "affirmative indication" in the Exchange Act that Section 10(b) applies extraterritorially.
Morrison involved the National Australia Bank Limited ("NAB"), the largest bank in Australia. Its "Ordinary Shares"–equivalent to common stock in the U.S.–are traded on the Australian Stock Exchange and other foreign exchanges, but not on any exchange in the U.S. NAB’s American Depositary Receipts ("ADRs"), which represent the right to receive a specified number of its Ordinary Shares, are traded on the New York Stock Exchange. Although one of the plaintiffs had purchased ADRs, his claims were dismissed for failing to allege damages and he did not appeal. The remaining plaintiffs had purchased the Bank’s Ordinary Shares on a foreign exchange. Plaintiffs alleged that some of the deceptive conduct occurred in Florida, where a wholly owned subsidiary of NAB was located. Plaintiffs alleged that this subsidiary misstated its earnings, which NAB incorporated into the financial statements it filed with Australian authorities. In 2001, NAB announced write-downs totaling nearly $2.25 billion, which caused a sharp drop in the prices of its Ordinary Shares.
The Supreme Court reasoned that the proper framework for interpreting the extraterritorial reach of Section 10(b) and Rule 10b-5 is through the "longstanding principle of American law ‘that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.’" Slip. Op. at 5 (citations omitted). The Court explicitly rejected the approach of the Second Circuit and other Circuits, which it characterized as attempting to "’discern’ whether Congress would have wanted the statute to apply" to fraudulent schemes "that involve conduct and effects abroad." Slip Op. at 6. This approach, the Court noted, "produced a collection of tests for divining what Congress would have wanted, complex in formulation and unpredictable in application." Id.
Applying the presumption against extraterritoriality, the Court found nothing on the face of Section 10(b) to suggest it applies abroad. Slip Op. at 13. The Court rejected the Solicitor General’s arguments that an extraterritorial application was implied by either the statute’s "general reference to foreign commerce" or its statement of purposes, which included a comment that "the "prices established and offered in such transactions are generally disseminated and quoted throughout the United States and foreign countries." 15 U. S. C. §78b(2). The Court found that "[t]he fleeting reference to the dissemination and quotation abroad of the prices of securities traded in domestic exchanges and markets cannot overcome the presumption against extraterritoriality." Slip Op. at 14. Finally, the Court noted that Section 30(a) of the Exchange Act, governing broker-dealers, does include a clear statement of extraterritorial application that would be "quite superfluous if the rest of the Exchange Act already applied to transactions on foreign exchanges." Id. at 15.
The Court also rejected the plaintiffs’ argument that they were not seeking extraterritorial application of Section 10(b) because they alleged that NAB’s subsidiary in Florida overstated the value of its mortgage servicing rights for loans issued to domestic borrowers. The Court stated that "the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case." Slip Op. at 17 (emphasis in original). Rather, the Court reasoned that the "focus of the Exchange Act is not upon the place where the deception occurred, but upon purchases and sales of securities in the United States." Id. The Court therefore concluded that "it is . . . only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which §10(b) applies." Id. at 18.
The Court emphasized that if Congress had intended for the Exchange Act to reach conduct in this country affecting exchanges or transactions abroad, the "probability of incompatibility with the applicable laws of other countries [was] so obvious" that Congress would have addressed the subject of conflicts with foreign laws and procedures. Id. at 20. Indeed, the Commonwealth of Australia, the United Kingdom, and the Republic of France all filed amicus briefs, as did several international and foreign organizations, "complain[ing] of the interference with foreign securities regulation that application of §10(b) abroad would produce." Id. at 20-21. The Court concluded that its "transactional test"–"whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange"–would avoid this consequence. Id. at 21.
Finally, the Court rejected the Solicitor General’s invitation to apply a different test that would extend Section 10(b) to cases in which "the fraud involves significant conduct in the United States that is material to the fraud’s success" because it would prevent the U.S. from becoming a "’Barbary Coast’ for malefactors perpetrating frauds in foreign markets." Id. The Court colorfully 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." Id. at 21-22.
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