Amputating the long arm of the law: an analysis of the U.S. Supreme Court's decision in Morrison and why s. 10(b) still reaches issuers of ADRs.

• Author: Maslo, Paul B.
• Position: American Depository Receipts

INTRODUCTION

The U.S. Supreme Court's recent decision in Morrison v. National Australia Bank has substantially shortened the reach of the anti-fraud provisions of the securities laws. (1) Before Morrison, the courts utilized the conduct and effects tests to determine whether [section] 10(b) of the Securities Exchange Act of 1934 applied. Under those tests, the statute reached fraudulent conduct that occurred in the U.S. and fraudulent conduct abroad that had a substantial effect in the U.S. In Morrison, however, the Supreme Court, in an opinion authored by Justice Antonin Scalia, held that regardless of where the fraudulent conduct occurs or whether the conduct has an effect in the U.S., the anti-fraud provisions of the Exchange Act apply only to transactions in securities that trade on a U.S. exchange or that are purchased in the U.S.

This Commentary reviews the conduct and effects tests and the Supreme Court's decision in Morrison. It then addresses the new transactional rule's impact on the application of the Exchange Act's antifraud provisions in several situations where courts before Morrison routinely allowed [section] 10(b) claims to proceed: (1) foreign-cubed actions (i.e., claims involving a foreign citizen's purchase of a foreign issuer's ordinary shares on a foreign exchange) where the fraud impacts U.S. investors or is executed in the U.S.; (2) cases involving a U.S. citizen's purchase of a foreign issuer's ordinary shares outside the U.S.; and (3) actions concerning the purchase of a foreign issuer's American Depository Receipts ("ADRs"). While courts are in agreement that the test articulated in Morrison prevents [section] 10(b) from reaching defendants in the first and second types of actions, they are in conflict as to whether ADR purchasers should be able to bring a claim. This Commentary argues that a recent district court decision wrongly decided the application of Morrison in the ADR context and that the new rule should not prevent most ADR purchasers from bringing a cause of action under [section] 10(b).

1. CONDUCT AND EFFECTS TESTS

   Before Morrison, courts looked at two factors to determine whether they possessed subject matter jurisdiction (2) over a [section] 10(b) claim: (1) whether the wrongful conduct occurred in the U.S. (the conduct test), or (2) whether the wrongful conduct, even if it occurred in a foreign country, had a substantial adverse effect on U.S. investors (the effects test).3 Even though a plaintiff needed only to satisfy either the conduct or the effects test to support a finding of subject matter jurisdiction, there was no requirement that the two tests be applied separately and distinctly from each other, and courts often found that "an admixture or combination of the two ... gives a better picture of whether there is sufficient United States involvement to justify the exercise of jurisdiction by an American court." (4)

   The courts focused "on the nature of conduct within the United States as it relates to carrying out the alleged fraudulent scheme" to determine whether subject matter jurisdiction existed under the conduct test. (5) The circuits were divided as to precisely what conduct was necessary to satisfy the test:

   The more restrictive position, generally that the domestic conduct must have been of "material importance" or "significant" to the fraud and have "directly caused" the alleged loss [wa]s followed in the Second, Fifth, and District of Columbia Circuits. In contrast, the Third, Eighth, and Ninth Circuits generally require[d] some lesser quantum of conduct. (6) Under the effects test, subject matter jurisdiction existed when fraudulent acts committed abroad resulted "in injury to purchasers or sellers of those securities in whom the United States has an interest, not where acts simply have an adverse affect on the American economy or American investors generally." (7) It conferred jurisdiction "where the harm inflicted on the foreign plaintiff actually causes harm to U.S. investors or markets because of the relationship between the foreign plaintiff and U.S. investors." (8)

   The fact-intensive nature of the analysis under each of these tests compelled the courts to exercise a great deal of discretion in determining whether [section] 10(b) applied, which resulted in judicial inconsistencies and created an atmosphere of uncertainty. (9)

2. MORRISON

   Morrison' s journey to the U.S. Supreme Court began in the Southern District of New York. (10) Plaintiffs alleged that National Australia Bank ("NAB"), Australia's largest bank, made false and misleading statements regarding HomeSide, its Florida-based mortgage servicing unit. NAB booked the present value of HomeSide' s mortgage servicing rights on its balance sheet, and plaintiffs claimed that a faulty valuation model was used. When the true value of the rights was revealed, NAB was forced to take a series of writedowns. As...