Extraterritoriality for Securities Fraud Post-morrison

• Publication year: 2014

Extraterritoriality for Securities Fraud Post-Morrison

John Koury

EXTRATERRITORIALITY FOR SECURITIES FRAUD POST-MORRISON

Introduction

In 2010, the Supreme Court decided Morrison v. National Australia Bank Ltd., which addressed the extraterritorial application of the Securities Exchange Act of 1934. In the late 1960s, the Second Circuit developed a set of tests allowing the extraterritorial enforcement of § 10b. In Morrison, the Supreme Court overturned the Second Circuit's precedents and established a new test. This essay will look at the history, current trends, and possible future developments with respect to extraterritoriality of securities enforcement.

I. Extraterritoriality in Pre-Morrison Era

During the pre-Morrison era, Schoenbaum and Leasco, both Second Circuit decisions, governed extraterritorial application of § 10b.¹ In Schoenbaum, the underlying conduct involved a Canadian corporation's sale of treasury shares in Canada. At the time of the sale, the Canadian corporation had publicly traded shares on the American stock market. The Second Circuit concluded that because the sale affected the common shares on the American stock market, the Exchange Act of 1934 had extraterritorial jurisdiction over conduct in Canada in order to "protect American investors."²

In Leasco, the underlying conduct involved the purchase of an English corporation's securities in England.³ Unlike Schoenbaum, the English corporation had no securities on American markets.⁴ The company that purchased the securities was American and some of the English corporation's fraudulent conduct occurred in the United States.⁵ The Second Circuit concluded that the Exchange Act could be read to have extraterritorial jurisdiction over the transaction in England because Congress had prescriptive

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jurisdiction to regulate the underlying conduct.⁶ The court reasoned that if the 1934 Congress had been presented with the facts in Leasco, the legislature would have wanted § 10b to apply.⁷

In the thirty years following Schoenbaum and Leasco, the Second Circuit used the principles of these cases to create a two-part disjunctive test. The first part, the "effects test," determined "whether the wrongful conduct had substantial effect in the United States or upon United States citizens."⁸ The second part, the "conduct test," determined whether the "wrongful conduct occurred in the United States."⁹ The result was a flexible test, which gave the Exchange Act extraterritorial reach for a § 10b violation that affected American interests. The test allowed the courts to reach fraudulent securities transactions by foreign companies in foreign markets when American investors were harmed.

The approach adopted by the Second Circuit was met with considerable criticism because its test led to an "assumption-driven analysis" due to the lack of any bright line rules.¹⁰ As a result, judges made case-by-case determinations, leaving foreign markets in the dark.¹¹ Other critics, attacking the original reasoning in Schoenbaum, claimed that Congress either rejected extraterritorial application or that congressional silence did not give the Second Circuit license to create a judge-made rule.¹² This criticism came primarily from outside the judicial system as the circuit courts tended to accept the "conduct" and "effects" test.

II. Morrison and its Progeny in Civil Cases

Justice Scalia's majority opinion in Morrison overturned the "conduct" and "effects" tests and replaced them with a "domestic transaction" test.¹³ In

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Morrison, the respondent, Australia National Bank, operated in Australia and had common stock on the Australian Stock Exchange Limited and other foreign exchange markets.¹⁴ The bank had no common stock on American exchange markets.¹⁵ The underlying fraudulent conduct occurred in Australia.¹⁶ The Second Circuit upheld the district court's dismissal of the case.¹⁷ The Second Circuit, applying the "conduct" test concluded that the "heart of the conduct" occurred in Australia.¹⁸ It therefore held that it did not have subject-matter jurisdiction over the fraudulent conduct.¹⁹

The Supreme Court affirmed the dismissal, but in a lengthy opinion, overturned the "conduct" and "effects" tests. Justice Scalia strongly criticized the Second Circuit for disregarding the presumption against extraterritorial jurisdiction without clear congressional intent.²⁰ Looking to the text of the Exchange Act, Justice Scalia did not find any textual support for extraterritorial application.²¹ Drawing analogies to the extraterritorial application of Title VII, in EEOC v. Arabian American Oil Co., the Court held that when an American company hires an American citizen to work abroad, Title VII does not apply because the law focuses on "domestic employment."²² Justice Scalia reasoned that the "focus" of the Exchange Act is on the deceptive conduct in relation to the purchase and sale of domestic securities.²³ Thus, the new test for the jurisdiction of the Exchange Act turns on the location of the transaction involving securities.²⁴ The Exchange Act will have jurisdiction if the transaction occurred in the United States.²⁵ Applying this new test to the facts of Morrison, the high court affirmed the dismissal of the case because the transaction for securities occurred in Australia.²⁶

In Absolute Activist Value Master Fund Ltd. v. Ficeto, the Second Circuit, applying Morrison, developed a definition for when a securities transaction is domestic. In Absolute Activist, a foreign company committed the fraudulent

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securities transaction.²⁷ Despite many connections to the United States, including victims' and perpetrators' residency in the United States, the court could not definitively show that the transaction took place on American soil.²⁸ Establishing a definition for domestic transaction, the court held that a "securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States."²⁹ Therefore, the court held that the transactions failed to satisfy the "domestic transaction" test established in Morrison.³⁰

III. Application to Criminal Cases

In United States v. Vilar, the Second Circuit applied Morrison to criminal prosecutions of securities fraud. The defendants executed a fraudulent securities scheme through a foreign company.³¹ The prosecution sought to establish jurisdiction through the old "conduct" and "effects" tests by limiting Morrison to civil cases.³² Following Justice Scalia's reasoning, Circuit Judge Cabranes concluded that the same justification for the presumption against extraterritoriality applied to criminal cases.³³...