Saturday, August 06, 2011

Securities Industry Asks Second Circuit to Invoke Supreme Court Morrison Doctrine on Extraterritorial Application of US Securities Regulations

The extraterritorial extension of US private securities antifraud provisions to an action seeking relief arising out of statements made by a foreign person regarding securities traded on a foreign exchange based on references to foreign securities in swap agreements poses heightened policy concerns given the magnitude and arbitrariness of the potential exposures, noted SIFMA and the Chamber of Commerce. In an amicus brief filed in what SIFMA and the Chamber called a critical challenge to the Supreme Court’s recent decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), amici said that the risk of liability based on references in swap agreements far exceeds the exposure for transactions in the underlying securities; and that the massive and arbitrary exposures that would arise from Section 10(b)’s extraterritorial application based on references in swap agreements would create a substantial disincentive to U.S. investment by foreign companies. In Morrison, the Court held that Rule 10b-5 reaches the use of a manipulative or deceptive device only in connection with the purchase or sale of a security listed on a US exchange, and the purchase or sale of any other security in the US. Viking Global Equities v. Porsche, CA-2.

Specifically, hedge funds alleged that Porsche, a German company, made fraudulent statements about its intentions regarding the shares of another German company, Volkswagen, which are traded on the German securities market. The only connection to the United States was a transaction unrelated to Porsche or the Volkswagen shares: the hedge funds alleged that they signed confirmations for swap agreements in the United States that used the price of the Volkswagen shares as a reference These swap agreements were privately negotiated, noted the brief, and the allegations did not identify the specific swap agreements on which the claims were based or disclose the counterparties to the swap agreements.

As the District Court recognized, said amici, application of the Exchange Act in these circumstances would have Section 10(b) govern all statements made by anyone anywhere in the world regarding a foreign security listed and traded outside the United States based merely on a U.S. person’s unilateral decision to enter into a swap transaction that refers to the foreign security.

Swap transactions reflect unilateral trading decisions of hedge funds and other private market participants, reasoned amici, and foreign issuers have no way to know, much less limit, the extent to which U.S. persons may wish to enter into swaps referencing their foreign securities. Market participants may enter into swap agreements and thus create potential litigation exposure even where a foreign issuer makes no effort at all to access U.S. securities markets. Indeed, the potential for liability extends even more broadly to non-U.S. persons who, as in this case, are not even the issuers of the securities referenced in the swap agreement, nor even alleged to have made any statements about a security traded in the United States

This action represents an effort to exceed Morrison’s limits, contended amici, It tries to recover losses resulting neither from transactions in securities listed on domestic exchanges nor domestic transactions in other securities.. Rather, it seeks to assert a claim against a foreign company to recover losses relating to shares of another foreign company traded on a foreign exchange based simply on the allegation that plaintiffs signed confirmations in the United States for swap transactions that refer to those foreign securities. This action thus risks precisely the harm to the U.S. economy and foreign investment that proper application of Morrison would preclude.

Congress, not the courts, has responsibility for making the sensitive and important policy determination of whether to extend extraterritorial application of the private right of action beyond Morrison’s bounds. Notably, under the Dodd-Frank Act, Congress has specifically called for the SEC to conduct a study and make recommendations regarding the extraterritorial scope of Rule 10b-5.

The SEC has solicited public input regarding this issue, including seeking information on the implications of extraterritorial application on international comity and the costs to domestic and international financial systems and securities markets. To date, the SEC has received over sixty comments from foreign governments, foreign trade associates and scholars, among others. The SEC must report its recommendations to Congress by January 21, 2012.

Building on principles of international comity, the Morrison Court expressly rejected the notion that the Exchange Act reaches conduct in the US affecting exchanges or transactions abroad.” The Court expressed concern with the interference with foreign securities regulation that application of § 10(b) abroad would produce, noting that the regulation of other countries often differs from the US as to what constitutes fraud, what disclosures must be made, what damages are recoverable, what discovery is available in litigation, what individual actions may be joined in a single suit, what attorney’s fees are recoverable, and many other matters. According to SIFMA and the Chamber, this case presents an unprecedented attempt, contrary to Morrison’s mandate, to extend the Exchange Act to conduct outside the United States affecting exchanges or transactions abroad.

It is through the legislative process, in this case Congress acting with the
benefit of informed study by an expert agency, and not creative litigation theories that the issue of whether to extend liability beyond Morrison should be addressed, said SIFMA, particularly given the magnitude of the potential exposures and economic impact at a time of major challenges to U.S. and global markets.

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