Appeals Court Curtails Extraterritorial Application of Federal Securities Laws

A Second Circuit panel has ruled that the US federal securities laws did not apply to foreign investors alleging fraudulent statements by a foreign issuer when the conduct in the US was merely preparatory to the fraud and the acts directly causing loss to investors occurred in a foreign country. This is the so-called foreign-cubed securities fraud action, said the appeals panel, and it is judged by the same standard of any extraterritorial application of the federal securities laws, which is whether actions in the US directly caused the loss to investors. The panel described itself as an American court, not the world’s court, which cannot expend resources resolving cases that do not affect Americans or involve fraud emanating from America. Morrison v. National Australian Bank, Ltd., CA-2, No.07-0583, Oct. 23, 2008.

Foreign investors alleged that a US subsidiary sent false financial information to its Australian parent company, which in turn created and distributed public filings incorporating the false statements. The main issue before the court was what conduct comprised the heart of the alleged fraud.

The appeals panel concluded that actions taken by the parent company in Australia were significantly more central to the fraud, and more directly responsible for harming investors, than the alleged manipulation at the US subsidiary. The parent is the public company with oversight over all corporate operations and the duty to file accurate financial statements to the outside world.

The subsidiary did not send any false numbers to investors, reasoned the court, and those numbers had to pass through a number of checkpoints manned by company personnel at the Australian headquarters before reaching investors. If headquarters had monitored the accuracy of the subsidiary’s numbers before transmitting them to investors, said the panel, the numbers would have been corrected and no investor would have been harmed.