US Supreme Court Invites SEC Input on Extraterritorial Reach of Federal Securities Laws

The US Supreme Court has asked the Government to file a brief in a private action involving the always vexing issue of the international reach of the federal securities laws. The appeal to the Court is from a Second Circuit panel ruling that federal courts had no jurisdiction over a securities fraud action against an Australian bank where the alleged fraudulent statements issued from the bank’s Australian headquarters and there was a complete lack of any US effect. CCH Fed. Sec. L . Rep. 94,880. The SEC had filed an amicus brief before the Second Circuit, arguing that US courts had jurisdiction since the information that made the statements in Australia false was generated in the US with the expectation that it would be distributed to foreign investors. The investor asked the Supreme Court to decide the issue in what appears to be the first of the foreign-cubed actions to reach the Court. Morrison v. National Australia Bank, Ltd, Dkt. No. 08-1191.

The rapid globalization of financial markets in recent years has cast into stark relief issues surrounding the international reach of US securities laws. In an amicus brief in the Second Circuit filed by the US Chamber of Commerce and the securities industry, it was argued that giving broad extraterritorial effect to federal securities fraud class action would reduce cross-border investment and deter foreign companies from accessing U.S. markets. For example, in this case, contended SIFMA, an Australian company listed on an Australian exchange with virtually all of its shareholders outside the United States faces the possibility of protracted litigation in the U.S. courts for alleged misstatements made to those non-U.S. investors.

The industry brief goes on to assert that no Congressional mandate or judicial precedent requires opening U.S. courts to these foreign-cubed securities class actions brought by foreign plaintiffs against foreign issuers based on the purchase or sale of securities in foreign countries. On the contrary, contended the brief, principles of comity and effective judicial administration favor the resolution of these actions in the courts of other countries.

The SEC urged the Second Circuit to adopt a test under which the antifraud provisions of the securities laws would apply to transnational frauds that result exclusively or principally in overseas losses if the conduct in the US is material to the fraud’s success and forms a substantial component of the fraudulent scheme. The test proposed by the Commission is an articulation of the conduct test and describes when an injury is considered to be sufficiently directly caused by US conduct to support jurisdiction, reflecting the fact that the Court has upheld jurisdiction even though the last event in effectuating the fraudulent scheme did not occur in this country.

Since the federal securities laws are silent on their international reach, federal courts developed tests, including the conduct test, which focuses on the nature of the conduct within the US as it relates to carrying out the alleged fraudulent scheme. A related purpose underlying the conduct test is ensuring international reciprocity. By extending US securities laws to prohibit fraudulent conduct in the US that injures overseas investors, explained the SEC, the US can reasonably expect other countries’ laws to offer comparable protection to prevent fraudulent conduct overseas that is directed towards US investors.

A key phrase in the SEC’s proposed test is that the conduct in the US be ``material to the fraud’s success.’’ According to the SEC, the materiality inquiry would ensure that the domestic conduct was an integral link in the chain of events in the transnational fraud leading to the overseas investors’ losses. The SEC pointed out that the use of the term “materiality” for the jurisdictional inquiry under its proposed conduct test should not be confused with the different concept of “materiality” as an element of a fraud violation.

The Commission believes that its proposed test sufficiently addresses concerns that an over-extension of US securities laws to foreign corporations whose shares trade overseas may discourage their investment in the United States. This concern must be balanced against the principle that the US should not be used as a base for engaging in fraudulent conduct that may injure foreign investors. The proposed standard strikes the proper balance by affording jurisdiction only where the conduct in the US constitutes a substantial portion of the fraud that is material to the success of the scheme.

In its brief, the industry argued that the application of US securities regulation to fundamentally foreign disputes raises a host of policy concerns. For example, it risks weakening core principles of comity, as well as creating a reciprocal risk of exposing U.S. companies to securities litigation in virtually any jurisdiction in which they have a subsidiary, even if their shares are traded exclusively by US investors. The securities industry also raised the risk of arbitrariness and inequity, with different companies subject to different liability regimes dependent solely on tenuous factors arising out of the location of business operations or other considerations unrelated to the investor protection objectives of the U.S. securities laws.

One amicus brief has been filed with the Supreme Court already. The National Association of Shareholder and Consumer Attorneys urges the Court to take the case and clarify the extraterritorial reach of the US federal securities laws.

According to the association, a three-way split has developed among the federal Circuit Courts of Appeal as to the proper scope of jurisdiction when conduct within the US results in fraud in connection with a transaction outside the US. The predominant difference among the Circuits is the degree to which the US-based conduct must be related causally to the fraud and the resulting harm to justify the application of the federal securities laws.

The Third, Eighth and Ninth Circuits have held that jurisdiction may be exercised when conduct within the US furthered the alleged fraud The Second, Fifth and Seventh Circuits have established a more restrictive test, holding that jurisdiction may be exercised only when conduct occurring within the US directly caused the alleged losses. Finally, the District of Columbia Circuit has adopted the most stringent test, holding that jurisdiction is proper only when the fraudulent statements or misrepresentations originate in the United States, are made with scienter and in connection with the purchase or sale of securities, and directly cause the harm to those who claim to be defrauded, even if reliance and damages occur elsewhere.