Tuesday, August 18, 2015

Morrison Limitations Don’t Apply to Advisers Act

By Matthew Garza, J.D.

An investment adviser that managed a Bermuda-based fund failed to convince the Sixth Circuit that the limitations on extra-territorial application of Exchange Act Section 10(b) established by Morrison v. National Australia Bank also applied to Investment Advisers Act Section 206. The Exchange Act focuses on the nature of the securities transaction, reasoned the court, while the Advisers Act focuses solely on the conduct of the adviser (Lay v. U.S., August 17, 2015, Merritt, G.).

Background. Mark D. Lay was convicted by a jury of fraud under Investment Advisers Act Section 206, as well as mail and wire fraud, based on advice he provided to the Ohio Bureau of Workers’ Compensation through his SEC-registered adviser, MDL Capital Management. MDL managed the Bureau’s investments in a U.S. fund focused on long-term Treasury bonds and also in a hedge fund it started in Bermuda. Lay leveraged the Bureau’s investments in the Bermuda fund in excess of the limitations agreed to and lost big, leaving the Bureau only $9 million out of a $225 million investment.

Lay was sentenced to 60 months in prison on the Advisers Act Section 206 count and concurrent sentences of 144 months on three wire and mail fraud charges. The Supreme Court’s decision in Morrison v. National Australia Bank limited the extra-territorial reach of Exchange Act Section 10(b), holding that because the Act is silent on the extra-territorial application of 10(b), it must presume that Congress intended to limit its application to securities transactions occurring with the U.S. The district court found that the fiduciary duty Lay owed to the Bureau was sufficient to satisfy the requirement in Morrison that the fraud was domestic.

Advisers Act. Lay argued that the Advisers Act is also silent as to its extra-territorial reach, and because the fund at issue was domiciled in Bermuda, he too should be considered outside of the reach of U.S. courts after Morrison. The Sixth Circuit disagreed. First, the Exchange Act and Advisers Act regulate different aspects of securities transactions, said the court, and second, the only aspect of the case not tied to the U.S. was the Bermuda-based fund. Lay had a “wholly domestic” relationship with the Ohio Bureau of Workers’ Compensation, said the court.

The court wrote that Advisers Act Section 206 establishes that registered investment advisers have federal fiduciary obligations of good faith, loyalty, and fair dealing to clients, whereas the Exchange Act does not set forth a standard of conduct for advisers. Lay tried to take the position that his client was the Bermuda fund and not the Ohio Bureau, but the court found that the original agreement to invest in Treasury bonds and the later in the Bermuda fund was a “single investment relationship” encompassing both the foreign and domestic funds.

Other distinctions between Morrison and Lay’s case also existed, said the court. First, this was a criminal case brought by U.S. authorities, not a private civil case. Second, unlike in Morrison, the plaintiff and defendant are both U.S. citizens. Third, the defendant managed both a domestic and U.S. fund as part of the same investment program. Fourth, the victim was an Ohio state agency holding money in trust for Ohio citizens, and fifth, the fraudulent conduct took place in the U.S.

The case is No. 13-4021.

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