"[T]he Lord gave, and the Lord hath taken away." Congress, with an assist from the Securities and Exchange Commission, has overruled the Supreme Court’s short-lived solution to the jurisdictional issues in "foreign-cubed" securities class action cases. The Dodd-Frank Wall Street Reform and Consumer Protection Act, among the many other changes it brought to the world of securities, commodities and banking regulation, also codified some of the SEC’s arguments in Morrison v. National Australia Bank, which were discussed here in a column I wrote in June.
A quick review: "Foreign-cubed" is a term for a securities class action brought in the United States by (1) foreign investors, against (2) a foreign issuer, regarding securities purchased or sold on (3) a foreign exchange or a foreign securities market. In Morrison, Australian investors sued the National Australia Bank for losses they claimed stemmed from fraudulent financial reporting by the bank’s Florida subsidiary. The bank countered that the Florida financial reports were compiled and reviewed in Australia, thereby making any connection to the U.S. tenuous at best. At issue was whether the conduct in Florida was substantial enough to support jurisdiction of the U.S. courts to hear the claim.
Sensibly enough, principles of jurisdiction generally require that the parties to a lawsuit have certain "minimum contacts" with a nation or state before they can be subject to action in its courts. As a basic principle, it makes obvious sense that French courts should not presume to decide a dispute between two citizens of India involving matters that arose entirely in India. India could be expected to have its own rules of law and its own methods and forums for hearing such disputes, and French courts would be meddling in internal Indian matters if they undertook to adjudicate such a dispute. Other situations are more difficult, however. Clearly the French courts do have at least some interest in providing a forum if the dispute is between a French citizen and a citizen of India, but how deeply must a French citizen be involved before the French courts will hear the case? Clearly, also, France may be the appropriate forum for a dispute between two Indian citizens over events that occurred entirely in France, but how much of the matter must have taken place in France before the French courts will get involved?
Prior to Morrison, in deciding whether to exercise jurisdiction in securities law cases, U.S. courts generally applied either the "conduct test" or the "effects test" to foreign-cubed situations. The conduct test would require courts to evaluate the extent to which the defendant’s conduct contributing to an alleged fraud actually took place in the United States–this test looks to the country’s interest in policing unlawful activity within its borders, even if the person harmed was not a U.S. citizen. The effects test, by contrast, focuses on whether the alleged fraud has an effect on U.S. investors trading on U.S. exchanges–that test looks to the country’s interest in protecting its own citizens from harm and protecting the integrity of U.S. institutions, even if the bad acts were committed outside the United States.
The lower courts hearing the Morrison case used the conduct test, and dismissed the case on the grounds that there were insufficient U.S. activities involved to support U.S. jurisdiction over the case. When the case reached the Supreme Court, debate raged over whether the conduct test or effects test should apply.
The SEC, in an amicus curiae brief arguing in its own interest, suggested a third solution. Agreeing with the lower courts, the SEC advocated for the dismissal of the private investors’ claims in Morrison, and argued that the traditional conduct test should be applied to private plaintiff’s suing for securities fraud. However, the SEC also proposed that less onerous forms of either the conduct or the effects test should be sufficient to determine whether the SEC itself could take action against foreign-cubed fraudsters. Thus, the SEC argued that it should be able to rely on a less stringent jurisdictional standard, since the SEC represents the nation’s interests both in regulating securities activity within the U.S. (conduct) and also in protecting U.S. investors and U.S. markets from fraud (effects).
In June 22, I advocated in this column in support of the SEC’s solution to the foreign-cubed problem. The SEC’s proposal balanced the interests of the United States in regulating fraud that touches domestic markets or investors with the interests of foreign jurisdictions in litigating private securities claims at home. As with any difficult case, reasonable people could differ, and many reasonable people disagreed with me, including at least one of my own partners.
Two days later, on June 24, the Supreme Court made it clear that it also disagreed with me. It dismissed the Morrison case and rejected the dual jurisdictional standards proposed by the SEC. However, the Court also appeared to disagree with everyone else, as it swept aside both the conduct test and the effects test and, most surprisingly, overturned what had been accepted precedent regarding the extent of the reach of U.S. law.
The Supreme Court examined Section 10(b) of the Exchange Act, and SEC Rule 10b-5 promulgated under that Section, which are the basic anti-fraud provisions of the U.S. federal securities laws. The Court determined that Section 10(b) did not have an extraterritorial reach. The Court then introduced a restrictive "transactional test" for determining U.S. jurisdiction in securities cases, decreeing that Section 10(b) applies only to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities." In other words, we could look at either conduct or effects to support U.S. jurisdiction, but if we looked at conduct, the conduct would have to rise to the level of actual domestic transactions in securities; if we looked at effects, the only relevant effects would be those on U.S. exchanges arising from transactions in listed securities.
Supreme Court decisions generally withstand the test of time. When the Supreme Court speaks, particularly when it speaks as clearly and decisively as it did in the Morrison opinion, its word becomes the law of the land. Only a subsequent Supreme Court decision or a Constitutionally sound act of Congress can overrule the Court. As applied to the SEC’s regulatory jurisdiction over foreign-cubed defendants, the transactional test set forth by the Supreme Court in Morrison remained the law of the land for exactly 27 days.
On July 21, President Barack Obama signed the Dodd-Frank Act into law. The Act directly reverses the Morrison decision as it pertains to regulatory actions brought by the SEC or the U.S. government. Specifically, Section 929P of the Dodd-Frank Act allows the SEC or the U.S. government to bring an action under Section 10(b) and Rule 10b-5 if it involves "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 conduct occurring outside the United States that has a foreseeable substantial effect within the United States." This language is very much in line with the SEC’s original proposal in Morrison.
The Dodd-Frank Act allows the Morrison test to stand as it applies to private actions under Section 10(b). However, the Dodd-Frank Act instructs the SEC to investigate whether the Act’s new "significant steps" conduct standard and "foreseeable substantial" effects standard should extend to private lawsuits.
New legislation always opens the doors to further litigation disputing the meanings and intentions of Congress in enacting the new provisions, but Dodd-Frank’s legislative history makes it clear that the drafters intended the Act to restore the SEC’s right to take regulatory action against foreign fraudsters.
I continue to believe that allowing the SEC the more lenient jurisdiction to regulate fraud strikes the proper public-policy balance. Foreign companies that list securities on U.S. exchanges or conduct significant U.S. operations should have to submit to the enforcement of U.S. laws. In times of continuing economic turmoil, the United States needs to take action to ensure it does not become a safe haven for foreign criminals. The threat of SEC regulation will appropriately deter fraudulent behavior.
That said, I believe the Morrison Court got it right in disallowing the private right of action in foreign-cubed cases. It is one thing to enforce U.S. regulation, but quite another to interfere with a foreign government’s control of private disputes among its own citizens. While the United States should not become a safe haven for fraud, neither should it offer a forum-shopping opportunity for foreign plaintiffs to bring suits that their own countries’ laws might not allow, unless the United States has some independent, substantial interest in the case.
What’s still open to question, however, is whether the "transactional test" applied in Morrison is the proper test for determining whether the United States has a substantial interest in a securities fraud case between private foreign litigants. Congress is looking to the SEC for guidance and it will be interesting to see whether the SEC recommends a return to the pre-Morrison conduct test that it recommended in its amicus brief, or whether it will embrace a more restrictive standard and follow the Morrison Court’s lead in attempting to curb private litigation.
Daniel Zinn is an associate at The Nelson Law Firm in White Plains, N.Y. Zinn is a contributor and columnist to Traders Magazine’s online edition. He can be reached at dzinn@nelsonlf.com
The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to Traderseditorial@sourcemedia.com
