U.S. Supreme Court Greatly Restricts Extraterritorial Application of Civil Securities Fraud Actions

Morrison v. National Australian Bank:

Both domestic and foreign Investors and issuers alike should take note of the Supreme Court’s recent opinion in Morrison v. National Australian Bank as it could have major implications for their ability to sue or be sued for securities fraud in the future.

In a ground breaking decision, the High Court in Morrison rejected years of federal jurisprudence on the extraterritorial application of US securities fraud legislation. In an opinion by Justice Scalia, the Court criticized the Second Circuit’s vaunted “conduct” and “effects” test for establishing subject matter jurisdiction over foreign investors trading foreign securities on foreign exchanges (the so called “foreign cubed” case). The Court found that the authority to hear a securities fraud case involving foreign investors and securities is a question of “merit” and not a question of subject matter jurisdiction. In other words, rather than diving into the particulars of the defendant’s conduct or the nationality of the parties, the Court found that the question is whether Section 10(b) gives rise to a private cause of action for securities that are traded outside of the territory of the United States.

In opposition to the Second Circuit’s test involving foreign securities traded on foreign exchanges, the Court promulgated the “transactional test” for determining the extraterritorial reach of US securities fraud laws. The Court held that “[T]hose purchase-and-sale transactions are the objects of the statue’s solicitude…And it is in our view only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which Section 10(b) applies.” A plain reading of the opinion seems to indicate that the threshold question is whether the security in question is traded on a US stock exchange. If it is not, then the transactional rule would seem to bar suit.

It should be noted, however, that the lower courts could have trouble in determining the meaning of the second prong of the transaction test, the “domestic transactions in other securities” language. One reading of this language could be simply that the Court is referring to American Depository Receipts (ADRs). This reading would seem to make sense as it parallels the Court’s dicta restricting Section 10(b) to US stock exchanges and limiting it to the territory of the US. But, the rule does not expressly mention ADRs. Therefore, a much more liberal reading of the opinion could construe the rule to, for example, provide a cause of action for the purchase of securities on a foreign exchange through the internet by a US citizen who is located in the U.S.

Even given the more liberal interpretation discussed above, it is not hard to imagine that application of the plain language of the Court’s opinion will have far reaching implications. Below are just a few questions that come to mind.

• If the transactional rule in fact bars all standing to sue for fraud in connection with securities traded on foreign exchanges, it could have a notable impact not just on foreign investors, but also on any domestic investors who trade on foreign exchanges. Hypothetically speaking, such investors would be barred from suit in the US in connection with those foreign traded securities and would have to seek redress in a foreign country under that country’s laws. .
• Foreign issuers may start declining registration on US stock exchanges in order to avoid costly US securities class actions.
• The opinion does not carve out an exception for the extraterritorial reach of SEC and DOJ actions. Thus, it could be construed to place the same limitations on these agencies as it does on private claimants..

The above are just some of the changes that one might anticipate as a result of the decision in Morrison. But, it should be noted that the Court’s ruling was based on the absence of language in Section 10(b) that would extend its reach to foreign investors and stock exchanges. Therefore, a congressional amendment to the SEA of 1934 would render the Court’s opinion moot. Stay tuned.

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