In the watershed decision of Morrison et al. v. National Australia Bank Ltd., the United States Supreme Court has held that private causes of action under Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act)1 may not be based on the purchase or sale of securities on foreign exchanges or on securities transactions otherwise occurring outside the United States.2
In so ruling on June 24, 2010, the Court reversed decades of precedent in federal appellate courts, which had developed various tests to determine when the extraterritorial application of Section 10(b) and its related Rule 10b-5 was appropriate.3 Instead of selecting among these tests or developing a different test, the Supreme Court found Congress did not intend Section 10(b) to apply extraterritorially. In the process, the Supreme Court made clear that the United States would not become a global forum for securities fraud cases imported from overseas securities exchanges even if the case involved US actors or US-based activity.
Section 10(b) of the Exchange Act authorizes the US Securities and Exchange Commission to promulgate rules forbidding "any manipulative or deceptive device or contrivance" used in connection with the purchase or sale of any security "registered on a national securities exchange or any security not so registered." Section 10(b) has long been understood to support a private cause of action against persons or entities violating SEC Rule 10b-5, which generally prohibits the use of deceptive acts or schemes to buy or sell securities.
At issue in Morrison was what has become known as a "foreign-cubed" or "f-cubed" set of facts, involving non-US investors who purchased shares of a non-US company on exchanges outside of the United States and who then bring suit in US courts. In Morrison, the plaintiffs resided outside of the US and purchased shares of the defendant National Australia Bank (NAB), Australia's largest bank, on the Australia Securities Exchange, the London Stock Exchange, the Tokyo Stock Exchange and the New Zealand stock exchange. While NAB has American Depositary Receipts (ADR) trading on the New York Stock Exchange, US ADR holders were not part of the case before the Supreme Court.
In 1998, NAB acquired a Florida-based mortgage service provider, Homeside Lending, Inc. In 2001, NAB disclosed that the interest assumptions in the valuation model used by Homeside to calculate the value of its mortgage servicing rights were incorrect, resulting in an overstatement in the value of those rights. NAB later announced that it would incur a $450 million write-down due to the recalculation of the value of those rights. NAB's common shares and its ADRs fell more than 5 percent after this news was announced. Shortly thereafter, NAB announced yet another write-down, this time for $1.75 billion and its shares fell by more 11.5 percent.
NAB's security holders sued in the US. Three of the four plaintiffs purchased their shares on exchanges outside the United States and sought to represent a class of non-American purchasers of NAB common shares. The fourth plaintiff purchased ADRs and sought to represent a class of American purchasers. The defendants moved to dismiss the claims of the non-US plaintiffs for lack of jurisdiction and those of the domestic plaintiff for failure to allege he suffered damages springing from the fraud. The district court dismissed all of the claims, and the non-US plaintiffs appealed. On the appeal before the Court of Appeals for the Second Circuit and the Supreme Court, only the foreign plaintiffs remained. None of them had purchased the defendant's securities on a US exchange or over-the-counter-market.
The Second Circuit, following its earlier decisions, employed a "conduct and effects" test to determine whether Section 10(b) should provide the foreign plaintiffs with a right of action. The conduct and effects test required the court to analyze "(1) whether the wrongful conduct occurred in the United States, and (2) whether the wrongful conduct had a substantial effect in the United States or upon United States citizens."4 Using this test, the Second Circuit held that any acts performed in the United States by NAB or Homeside did not "compris[e] the heart of the alleged fraud," and thus affirmed the dismissal of the plaintiffs' claims.5 Subsequently, the Supreme Court accepted the plaintiffs' appeal.
Writing for the majority, Justice Antonin Scalia affirmed the dismissal of the plaintiffs' claims, but rejected the Second Circuit's conduct and effects test. Instead, the Court established a bright-line rule against the extraterritorial application of Section 10(b), holding that a cause of action exists only for securities listed on US exchanges or domestic transactions in other securities, to which Section 10(b) applies.6 Relying on the "longstanding principle of American law" that Congress does not intend a statute to apply extraterritorially absent an indication otherwise, the Supreme Court found nothing on the face of Section 10(b) or the Exchange Act to suggest that Congress meant Section 10(b) to apply extraterritorially.7
The Supreme Court also rejected the plaintiffs' arguments that Section 10(b) should apply because some of the allegedly deceptive conduct occurred in the United States.8 The plaintiffs alleged that the deceptive calculations regarding mortgage servicing rights were performed in Florida, where Homeside was located, and that individual defendants made misleading statements from the United States.9 The Supreme Court dismissed these arguments, finding that the "focus" of the Exchange Act was not on the place of the deceptive conduct, but rather on whether the violative conduct occurred in connection with either the purchase or sale of a security listed on a US exchange or in the United States.10 That the allegedly fraudulent conduct had some connection to the United States was insufficient; rather, the transaction in the underlying securities must have occurred in the United States.
Concurring in part and in the judgment, Justice Stephen Breyer agreed that the securities at issue in Morrison were not purchased on any "national securities exchange," nor did they fall into the category of "any security not so registered."11 Justice Breyer also noted that other state and federal laws may give rise to a cause of action for the fraudulent conduct alleged by the plaintiffs.12 Justice Breyer concluded by noting, however, that the case did not require the Court to "consider other circumstances" beyond these narrow issues.
Concurring only in the judgment, Justices John Paul Stevens and Ruth Bader Ginsburg took issue with the majority's purely statutory analysis of the case and with its dismissal of "the long pedigree of, and the persuasive account of congressional intent embodied in, the Second Circuit's" conduct and effects test.13 Justices Stevens and Ginsburg viewed the issue presented as "how much, and what kinds of, domestic contacts are sufficient to trigger application of §10(b)."14 Instead of casting aside decades of judicial precedent, Justices Stevens and Ginsburg would have made the Second Circuit's conduct and effects test the standard for determining extraterritorial application of Section 10(b).15 Regardless, they concurred in the majority's judgment because they found this case presented insufficient links to the US and instead had "Australia written all over it."16
Morrison marks a significant and welcome departure from past, uncertain applications of Section 10(b) in foreign-cubed cases. Significantly, however, the decision in Morrison addresses only private causes of action under Section 10(b) of the Exchange Act. As Justices Stevens and Ginsburg noted in their concurring opinion, "[t]he Court's opinion does not . . . foreclose the [SEC] from bringing enforcement actions in additional circumstances, as no issue concerning the [SEC's] authority is presented by this case."17 Thus, the Court left for another day the issue of whether the SEC may bring an enforcement proceeding in a foreign-cubed situation such as Morrison.
Additionally, pending legislation in the US Congress may pose a threat to the continued viability of the holding in Morrison. The Investor Protection and Securities Reform Act of 2010, currently before the US House Committee on Financial Services, would amend the US securities laws to give US courts jurisdiction over violations of the Securities Act of 1933,18 the Investment Advisers Act of 1940,19 and the Exchange Act where there is:
(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 with in the United States.20
In addition, the pending legislation would direct the SEC, within 18 months after enactment, to report (after comment and study) on the extent to which private rights of action under the Exchange Act should be extended to cover the conduct described above.21
Footnotes
1.15 U.S.C. § 78(j)(b).
2.No. 08-1991, 2010 WL 2518523, at *3-4 (U.S. June 24, 2010).
3.See id. at 5-8 (discussing tests developed by various circuit courts of appeal).
4. 547 F.3d 167, 171 (2d Cir. 2008).
5.Id. at 175-76.
6.No. 08-1991, 2010 WL 2518523, at *11 (U.S. June 24, 2010).
7.Id. at 9.
8.Id. at 11.
9.Id.
10.Id.
11.Id. at 14.
12.Id.
13.Id. at 18.
14.Id.
15.Id. at 18-11.
16.Id. at 20.
17.Id. at 19, fn. 12.
18.15 U.S.C. § 77 et seq.
19.15 U.S.C. § 80(b)-1 et seq.
20.See Dodd-Frank Wall Street Reform and Consumer Protection Act, Title IX, as amended June 26, 2010, 5:27 p.m., Sec. 929P ("Strengthening Enforcement by the Commission"), available here. http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/Financial_Regulatory_Reform062410.html .
21.See id., Sec. 929Y ("Study on Extraterritorial Private Rights of Action").
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