On April 11, 2012, the Staff of the U.S. Securities and Exchange Commission ("SEC" or "Commission") released its long-awaited study ("Study") on the cross-border scope of private suits under Section 10(b) of the Securities Exchange Act of 1934. The Study, available at http://www.sec.gov/news/studies/2012/929y-study-cross-border-private-rights.pdf, derives from Section 929Y of the Dodd-Frank Act, which directed the SEC to study whether, and to what extent, private suits under Section 10(b) should be extended to transnational securities frauds in light of the Supreme Court's decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010). After reviewing 72 public comment letters and considering various alternative approaches--and without offering a specific recommendation--the Study sets forth a series of options and policy considerations for Congress to consider in determining whether to enact legislation governing the cross-border reach of private Section 10(b) actions, and if so, what standard to apply to such actions. The Commission has expressed no view regarding the Study, although Commissioner Aguilar issued a "dissenting statement" criticizing the Study for, in his view, failing both to provide a specific recommendation and to depict fully the investor harm resulting from Morrison. See Statement by Commissioner Aguilar, Defrauded Investors Deserve Their Day in Court (Apr. 11, 2012), available at http://www.sec.gov/news/speech/2012/spch041112laa.htm. * * *
In June 2010, the Supreme Court held in Morrison that Section 10(b) applies only to frauds "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." 130 S. Ct. at 2888. This test, commonly known as the "transactional test," replaced the so-called "conduct and effects" tests that lower courts had previously used to determine the cross-border reach of Section 10(b).
Under the "conduct test," Section 10(b) applied if a sufficient level of conduct comprising the transnational fraud occurred in the United States, even if the injured investors or the purchase and sales were overseas. Id. at 2879. Under the "effects" test, Section 10(b) applied if foreign conduct caused direct and foreseeable substantial effects in the United States or on United States citizens. Id.
In Morrison, the Court rejected both of those tests. The Court reasoned that they lacked any textual basis, were difficult to administer, and improperly ignored the presumption against extraterritoriality. Id. at 2878-79. The Court then reaffirmed the presumption against extraterritoriality and found no affirmative evidence in Section 10(b) that Congress intended for it to apply extraterritorially. Id. at 2881-83. Finally, the Court analyzed the text of Section 10(b) to determine what it prohibits domestically and concluded that it targets fraud in connection with "purchase and sale" transactions of securities. Id. at 2884-85. Based on that transactional focus, the Court adopted its new "transactional test," under which Section 10(b) applies only to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities." Id. at 2884.
In the Dodd-Frank Act, Congress responded to Morrison by enabling the SEC and the U.S. Department of Justice to rely on a codified version of the conduct and effects tests in bringing enforcement actions under Section 10(b). With respect to private actions, however, Congress instead directed the SEC to solicit public comment and then to publish a study considering whether, and to what extent, to restore the conduct and effects tests for private actions as well. In doing so, Congress specified that the SEC should consider the scope of such a cross-border private right of action and its potential costs and benefits, including the implications on international comity.
The Staff of the SEC published its Study on April 11, 2012. The body of the Study is 70-pages long and contains several sections. First, it recounts the state of the conduct and effects tests before Morrison, the Morrison litigation, and issues addressed in post-Morrison decisions. Those issues include, for example, (1) how courts have determined whether a purchase or sale of securities not listed on a U.S. exchange takes place in the United States; (2) how the transactional test applies when actors other than the issuer--such as investment advisers, broker-dealers, and underwriters--engage in fraudulent conduct; and (3) how the transactional test applies to security-based swap transactions that reference securities traded on foreign exchanges.
Next, the Study details the arguments raised in the 72 comment letters received by the SEC. Some comments, for instance, including those submitted by foreign governmental authorities, law firms, and accounting firms, favored the Morrison transactional test and counseled against extending the conduct and effects tests to Section 10(b) private actions--reasoning that doing so would create conflicts with other nations, trigger abusive litigation, and impede market growth. Other comments, by contrast, including several submitted by foreign pension funds, criticized the transactional test for creating uncertainty about where securities transactions take place and for depriving investors of a remedy in situations where they are induced in the United States to buy securities overseas.
The Study then reviews six alternative approaches that Congress might wish to consider in extending the Section 10(b) private action extraterritorially, with a seventh option of passing no legislation and allowing the courts to continue interpreting the Morrison holding. Id. at 58-69. The first three alternatives call for reinstating the conduct and effects tests (or some formulation thereof). They include:
- restoring for private actions the same conduct and effects tests used in actions brought by the SEC and the U.S. Department of Justice;
- restoring the conduct and effects tests available to the SEC and the U.S. Department of Justice but imposing a "direct injury requirement" under which a private plaintiff must show "that the plaintiff's injury resulted directly from conduct within the United States," Id. at 61; or
- restoring the conduct and effects tests but allowing only U.S. investors to sue.
The second of these--a conduct test with a "direct injury requirement"--is the same formulation that the SEC and the Solicitor General advanced in Morrison with respect to private suits under Section 10(b), and as the Study notes, the "Commission has not altered its view in support of this standard." Id. at 22, 61. According to the Study, this formulation has several advantages: it furthers the goal of deterring fraudulent conduct that emanates from the U.S.; it weeds out claims that have closer connections to other jurisdictions; it lessens the risk of interference with foreign securities regulators by limiting the right of action to cases in which the conduct is closely linked to the alleged injury; and it reduces the risk of diverting U.S. resources to harms with only attenuated connections to the United States. Id. at 61-63. At the same time, however, the Study acknowledges that a direct-injury requirement could still create challenges to international comity and impose significant costs on U.S. courts and foreign corporations. Id. at 63.
The final three alternatives call for supplementing and clarifying the Morrison transactional test. These include:
- allowing investors to sue if the security as to which fraud is alleged is of the same class of securities registered in the United States, regardless of where the actual transaction takes place;
- permitting investors to sue if they can show that they were induced while in the United States to engage in the transactions, regardless of where the actual transaction occurs; or
- clarifying that an off-exchange transaction takes place in the United States if either the party made the offer to sell or buy, or accepted the offer to sell or buy, while in the United States. Id. at 58-69.
As the Study explains, all of these options "involve policy trade-offs that could carry significant implications in many areas, including investor protection and international comity." Id. at 60. It concludes by noting that "[a]bsent legislation, lower federal courts in particular will likely be called upon to resolve myriad novel and difficult issues regarding the application of the new transactional test." Id. at 70. Until such time as there is new legislation, the policy considerations elucidated by the Study may well prove to play a prominent role in judicial decisions that continue to grapple with the application of the transactional test.