Transnational Securities Fraud
On April 11th, the SEC published a study, required by the Dodd-Frank Act, regarding the application of Section 10(b) of the Securities Exchange Act to private actions alleging transnational securities frauds.
In 2010, the Supreme Court held that Section 10(b) only applies to transactions in securities listed on domestic exchanges or “domestic” transactions in other securities. Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010). Concerned that the decision would limit the ability of the SEC and Justice Department to pursue transnational securities frauds, Congress included in the Dodd-Frank Act a provision explicitly stating that Section 10(b) is intended to apply extraterritorially in enforcement matters in which the fraudulent conduct occurred in the U.S. or the fraud had a substantial and foreseeable effect in the U.S. Congress did not, however, extend this “conduct and effects” test to private actions for transnational securities fraud. Instead, it required the SEC to study the matter.
Since Morrison, federal courts faced with whether Section 10(b) applies to a transnational private securities fraud suit have generally divided transnational securities frauds into two types: those that involve a security listed on a domestic exchange and those whose circumstances are otherwise “domestic” within the meaning of Morrison.
Addressing the first prong, whether the security is listed on a domestic exchange, the study notes that if a security is cross-listed on both a U.S. and a foreign exchange, Section 10(b) will apply only if the transaction at issue was executed on the U.S. exchange. Transactions involving American Depository Receipts (“ADRs”) also fall within Section 10(b)’s parameters, although one district court has held that a transaction in over-the-counter ADRs is not subject to Section 10(b). Courts have further held that a U.S. investor’s purchase or sale of a foreign security via a foreign exchange also falls outside of Section 10(b)’s reach.
Turning to the second prong, whether the circumstances are otherwise “domestic,” the courts have employed potentially competing approaches. One presupposes that securities transactions may take place across more than one jurisdiction. Under this approach, courts must examine the entire transaction process to determine if any of the critical steps occurred domestically.
Another approach examines the transaction to determine precisely when in the course of the purchase or sale “the parties incurred ‘irrevocable liability’ to complete the transaction.” Still other courts have suggested that either the issuance of the securities in the U.S. or transfer of title to the shares in the U.S. may be sufficient.
Post-Morrison, courts have further held that Section 10(b) does not apply if the transaction occurred either on a foreign exchange or otherwise outside the United States, even if an intermediary resided in the U.S. and primarily engaged in the fraudulent conduct inside the U.S.
After summarizing the comments it received, the SEC discussed the options open to Congress as it considers whether and how to extend Section 10(b) to private transnational securities frauds.
The Conduct and Effects Test
The agency quickly dismissed extending to private lawsuits the pre-Morrison conduct and effects test made available to enforcement agencies in the Dodd-Frank Act. It doing so, it noted the international law and comity implications such an extension would bring. Commission staff more seriously discussed a conduct and effects test which requires a direct injury from conduct occurring in the U.S. Alternatively, a conduct and effects test which applied only to U.S. investors was suggested.
The Transactional Test
Turning to the transactional test adopted by Morrison, the SEC considered four alternatives: permitting investors to pursue a Section 10(b) claim for a purchase or sale of any security that is of the same class of securities registered in the U.S., regardless of the actual location of the transaction; authorizing private actions against securities intermediaries that engage in fraud while purchasing or selling securities overseas for U.S. investors; permitting private Section 10(b) actions if an investor can demonstrate that inducement occurred while the investor was in the U.S. to engage in the transaction, irrespective of where the actual transaction occurred; and clarifying that an off-exchange transaction takes place in the U.S. if either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the U.S.
Commissioner Luis A. Aguilar issued a strongly worded dissent to the SEC study. He expressed amazed disappointment that the staff of an investor protection agency would fail to recommend that Congress authorize private lawsuits in the transnational securities context. He countered international law and comity concerns by noting that neither prohibits the U.S. from enforcing a legal duty owed in multiple jurisdictions. Aguilar additionally noted that Congress has traditionally recognized the need and importance for private enforcement.