Supreme Court Oral Argument Pits Extraterritorial Reach of Rule 10b-5 against Sovereign Right to Remedy Securities Fraud

In what is perhaps the first foreign-cubed case to reach the U.S. Supreme Court, foreign investors who purchased stock in a foreign bank on a foreign exchange, with alleged significant fraudulent conduct having occurred in the U.S., pitted their Rule 10b-5 remedy in federal court against the sovereign right of another nation to remedy securities fraud in its own way. In the oral arguments, the Justices weighed the vexing question of the right of U.S. courts to remedy securities fraud with respect for the right of other nations to enforce their own securities regulatory regimes.

The Court is reviewing a Second Circuit panel ruling that the U.S. federal securities laws did not apply to foreign investors alleging fraudulent statements by a foreign issuer when the conduct in the U.S. was merely preparatory to the fraud and the acts directly causing loss to investors occurred outside the U.S. Morrison v. National Australian Bank, Ltd., CA-2, Dkt. No. 08-1191.

Arguing for the Australian bank, George Conway said that the investors identified nothing in the text of Section 10(b) that overcomes the presumption against its extraterritoriality application. The statute should thus be construed not to apply to transactions and shares of foreign issuers on foreign exchanges. Noting that there is an implied private right of action under Rule 10b-5, counsel asserted that Congress did not intend for this right of action to exist even domestically, let alone extraterritorially.

Moreover, given the threat that the Rule 10b-5 implied right presents to the sovereign authority of other nations, as reflected in the amicus briefs of Australia, the United Kingdom, and France, counsel asked the Court not to construe the implied right to extend to claims of purchasers and sellers of securities of foreign issuers on foreign markets. In separate amicus briefs, the U.K. and France cited international comity in urging the Court not to allow the application of Rule 10b-5 to upset the delicate balance that foreign nations have struck in regulating securities fraud and thereby offend the sovereign interests of foreign nations.

Counsel also stressed the dangers of conflict with foreign law, particularly in the context of the modern Rule 10b-5, with its fraud on the market presumption, which Australia does not recognize. The investors are essentially seeking to have a U.S. federal court conduct a massive transfer of wealth and impose a direct form of market regulation that Australia has not seen fit to impose upon itself, said counsel.

Counsel also noted that Congress can speak clearly on these issues when it wants to, citing Exchange Act Section 30(a), which authorizes the SEC to promulgate regulations that apply to brokers and dealers who effect transactions of securities on foreign exchanges, if those transactions are transactions of shares of shares of U.S. issuers. Congress did not speak so clearly in Section 10(b).

Counsel noted that the amicus briefs of different nations display different rules of materiality and disclosure. Also, some countries rely on public enforcement more than others. The French rely on l'action publique, while other nations approach the U.S. in their generosity to plaintiffs. Australia allows opt-out class action. Canada dispenses with the proof of reliance and scienter in some cases.

Justice Breyer wondered how it would hurt other countries if the Court said that if some terribly bad conduct happens in the United States, and someone in the world buys some shares and as a result is hurt, U.S. courts will give them a remedy. How does that hurt Australia or France or England, queried the Justice. In response, counsel reiterated that Australia does not permit fraud-on-the-market class actions and Canada caps damages at 5 percent of an issuer's market capitalization or $1 million, whichever is greater.

So it is not just substance, argued counsel, it is also remedy. Other nations want to do things in different ways and they should be allowed to. Nations should be allowed to judge for themselves what kind of rules they want to have for people who buy shares on their own exchanges. Counsel emphasized that applying section 10(b) to cases like this would amount to legal imperialism.
Arguing for the U.S., Assistant Solicitor General Matthew Roberts asserted that the critical question is whether there is significant conduct in the U.S. that is material to the broad success of the alleged securities fraud. In counsel’s view, to say that Rule 10b-5 does not cover that kind of conduct risks allowing the United States to become a base for orchestrating securities frauds for export.

It would allow masterminds in the United States to engineer international boiler room schemes in which they direct agents in foreign countries to make fraudulent representations that victimize investors. According to the government, the critical question must be whether there was culpable conduct in the United States that is directly responsible for the plaintiff's injury. The fact that the transaction happened on the Australian exchange is not dispositive.

Arguing for the investors, Thomas Dubbs said the scope of section 10(b) extends to remedy alleged fraudulent conduct with respect to misleading financial information sent by the bank’s Florida subsidiary to Australia for incorporation into the financial statements of the Australian bank.

He disagreed with the observation that this case has "Australia" written all over it. Indeed, from the investor’s point of view it has "Florida" written all over it, he said, because Florida is where the alleged fraudulent conduct in putting the phony assumptions into the valuation portfolio was done. Senior management in Florida created those numbers with the expectation and the knowledge that they would go into the financial statement, he said, which means that there is substantial conduct in Florida in terms of the fraud.

Justice Breyer returned to the fact that France, Britain and Australia have filed briefs in this case giving what they consider very sound reasons why the Court should not assert jurisdiction because of a number of conflicts that would interfere with their efforts to regulate their own securities markets. Justice Scalia was dubious of allowing a U.S. court to determine whether there has been a misrepresentation on the Australian exchange and whether Australian purchasers relied upon that misrepresentation.

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