An SEC study mandated by the Dodd-Frank Act on cross-border private securities fraud actions affirmed the Commission’s view that Congress should enact some form of the conduct and effects test for Rule 10b-5 private actions. In addition to possible enactment of some form of conduct and effects tests, the study details options to supplement and clarify the Morrison transactional test, one of which is to permit investors to pursue a Rule 10b-5 private action for the purchase or sale of any security that is of the same class of securities registered in the United States, irrespective of the actual location of the transaction.
In Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), the US Supreme Court adopted a new transactional test under which 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 an American stock exchange, and the purchase or sale of any other security in the United States.
Congress responded to the decision by adding Section 929P(b)(2) of the Dodd-Frank to provide the necessary affirmative indication of extraterritoriality for Section 10(b) actions involving transnational securities frauds brought by the SEC and the Justice Department. With respect to private Rule 10b-5 actions, Section 929Y of the Dodd-Frank Act directed the Commission to study the extension of the cross-border scope of private actions in a similar fashion, or in some narrower manner.
Prior to the Supreme Court’s decision, the lower federal courts had applied two tests to determine the cross-border reach of Rule 10b-5. Under the conduct test, Section 10(b) applied if a sufficient level of conduct comprising the transnational fraud occurred in the United States, even if the victims or the purchases and sales were overseas. Under the effects test, Section 10(b) applied to transnational securities frauds when conduct occurring in foreign countries caused foreseeable and substantial harm to U.S. interests.
The SEC study concluded that the enactment of conduct and effects tests for Section 10(b) private actions similar to the test enacted for Commission and DOJ enforcement actions is one potential option. Consideration might also be given to alternative approaches focusing on narrowing the conduct test’s scope to ameliorate those concerns that have been voiced about the negative consequences of a broad conduct test.
One such approach, which the SEC recommended in the Morrison litigation, would be to require plaintiffs to demonstrate that their injury resulted directly from conduct within the United States, which could mitigate the risk of potential conflict with foreign nations’ laws by limiting the availability of a Section 10(b) private remedy to situations in which the domestic conduct is closely linked to the overseas injury. The Commission has not altered its view in support of this standard. Another option is to enact conduct and effects tests only for U.S. resident investors. Such an approach could limit the potential conflict between U.S. and foreign law, reasoned the SEC, while still protecting U.S. investors and U.S. markets.
In addition to possible enactment of some form of conduct and effects tests, the study sets forth four options for consideration to supplement and clarify the transactional test. One option is to permit investors to pursue a Section 10(b) private action for the purchase or sale of any security that is of the same class of securities registered in the United States, irrespective of the actual location of the transaction. A second option, which is not exclusive of other options, is to authorize Section 10(b) private actions against securities intermediaries such as broker-dealers and investment advisers that engage in securities fraud while purchasing or selling securities overseas for U.S. investors or providing other services related to overseas securities transactions to U.S. investors.
A third option is to permit investors to pursue a Section 10(b) private action if they can demonstrate that they were fraudulently induced while in the United States to engage in the transaction, irrespective of where the actual transaction takes place. A final option is to clarify that an off-exchange transaction takes place in the United States if either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the United States.