On January 24, 2019, the U.S. Court of Appeals for the Tenth Circuit ruled that the antifraud provisions of the U.S. federal securities laws apply extraterritorially in enforcement cases brought by the U.S. Securities and Exchange Commission where the conduct-and-effects test contained in § 929P(b) of the Dodd-Frank Act is met. The Tenth Circuit's ruling is significant because it departs from the Supreme Court's 2010 decision in Morrison v. National Australia Bank Ltd., which preceded the Dodd-Frank Act and had limited the substantive application of the antifraud provisions of the federal securities laws to securities transactions that take place within the United States. SEC v. Scoville appears to be the first case to address the impact of the Dodd-Frank amendments on Morrison's transactional test, and appears to hold that § 929P(b) superseded Morrison in the context of SEC enforcement cases. As discussed below, there is a potential for a circuit split on this question that bears monitoring.
Although the application of the Scoville ruling is technically limited to cases arising in the Tenth Circuit, the ruling could potentially embolden the SEC to broadly pursue more cases involving extraterritorial conduct. Having said that, it still remains to be seen whether other circuits will agree with the Tenth Circuit's conclusion that § 929P(b) of Dodd-Frank's express conferral of jurisdiction in these circumstances coupled with evidence of Congressional intent for extraterritorial application is sufficient to overcome the central tenet of Morrison—that on a substantive basis, the scope of § 10(b) is limited to domestic transactions and that Morrison in no way addressed jurisdiction.
In Scoville, the SEC brought a civil enforcement action under § 17(a) of the Securities Act of 1933 and § 10(b) of the Securities Exchange Act of 1934 against Charles Scoville and his company, Traffic Monsoon, which operated an internet traffic exchange that involved the sale of several online advertising services, including a product called an “Adpack.” According to the SEC, through an Adpack, a Traffic Monsoon member not only purchased advertising services, but also could share in the company’s revenue, putting Adpacks under the definition of an investment contract "security" under the Securities Act of 1933. The SEC also alleged that the Adpacks operated as a Ponzi scheme, because the money paid to Adpack investors was generated by the sale of additional Adpacks. Ninety percent of Adpacks were sold to people outside the United States. The SEC obtained preliminary injunctive relief ordering, among other things, the freezing of tens of millions of dollars in the defendants’ assets. Mr. Scoville appealed those orders arguing, in part, that the antifraud provisions of the securities laws do not apply to the offer, sale or purchase of Adpacks outside of the United States.
In challenging the SEC's preliminary orders, the defendants in this case claimed that the federal securities laws did not apply to their conduct outside the US. The defendants relied on the Supreme Court’s 2010 decision in Morrison, which had held that the antifraud provisions applied only to the purchase or sale of securities on a U.S. domestic exchange or to other U.S. domestic securities transactions and did not apply to the purchase by Australian nationals of stock in an Australian company over an Australian stock exchange. The friction in Scoville, and the larger question of whether the SEC may obtain relief in enforcement actions involving extraterritorial conduct, harkens back to the historical view, pre-Morrison, that whether the antifraud provisions applied to extraterritorial conduct was a jurisdictional question, addressed under a conduct-and-effects test. The Morrison decision was notable, as Scoville suggests, because it expressly rejected this conventional wisdom. As the Scoville decision explained, Morrison “concluded that the courts of appeals were wrong to apply their conduct-and-effects tests to determine when § 10(b) applied outside the United States because § 10(b) simply did not apply extraterritorially. Instead, focusing on the language of § 10(b), the Court held that that antifraud provision only applied domestically; that is, to fraud only 'in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.'"
Significantly, Morrison was decided one month before the Dodd-Frank Act amended the antifraud provisions of both the 1933 and 1934 securities acts to add language regarding conduct abroad. The defendants claimed that Dodd-Frank could have explicitly overruled Morrison, but chose not to. The Tenth Circuit, however, highlighted the impossibility of Congress altering the draft Act in such a short timeframe. The Tenth Circuit reviewed the text, background and the legislative history of the Dodd-Frank amendments and found that Congress clearly “directed that those provisions apply extraterritorially in an enforcement action,” and the Dodd-Frank Act codified the “conduct-and-effects” test. The court determined that the amended Act applies extraterritorially in SEC enforcement actions alleging antifraud violations involving “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”
Applying this test, the court agreed with the district court that Traffic Monsoon’s sale of Adpacks outside the United States met the “conduct” prong of the test. The court's decision highlighted that Mr. Scoville “is the sole member, manager and registered agent of Traffic Monsoon, a Utah limited liability company,” that Mr. Scoville “conceived and created Traffic Monsoon in the United States,” that through the company “he created and promoted the Adpack investments over the internet while residing in Utah,” and also that “the servers housing the Traffic Monsoon website were physically located in the United States.” In Scoville, the “conduct within the United States” was extensive, making for a straightforward application of the test. In future cases, courts will certainly face more ambiguous facts and will have to define the contours of when an activity within the United States constitutes significant steps in furtherance of an alleged violation, or whether conduct abroad has a foreseeable substantial effect within the United States. The same uncertainty may return that led the Supreme Court to criticize those tests so vigorously in Morrison.
Furthermore, other circuits may find it difficult to square the Tenth Circuit's logic in this case with the different coverages of Dodd-Frank and Morrison. The Tenth Circuit's decision that the antifraud provisions apply extraterritorially (a point directly contrary to Morrison) is largely premised upon the short period of time between the ruling in Morrison and the enactment of Dodd-Frank alongside the-then prevailing wisdom in the legal community that these were jurisdictional questions, and that is how Congress was looking to resolve the question back in 2010. While there is an allure to this reasoning, the fact remains that Dodd-Frank, facially, only confers jurisdiction, whereas Morrison ruled that substantively, § 10(b) did not apply to foreign conduct and only applied to domestic transactions. This is an area that seems ripe for further litigation, and, perhaps, a legislative solution.
In spite of those challenges, the Tenth Circuit’s decision in Scoville could further embolden a return to a broader scope for SEC enforcement of the antifraud provisions. Individuals and companies that take part in transactions abroad should consider any touch points with the United States and should assume that the SEC may exercise its extensive investigative and enforcement powers even in extraterritorial transactions.