Corporate Governance

Morrison, Tourre, and the Misguided Interpretation of Rule 10b-5 (The Reverse Conduct and Effects Test) (Part 4B)

By J Robert Brown Jr.

We are discussing Morrison v. National Australia Bank, 130 S. Ct. 2869 (June 24, 2010), the Supreme Court case that held Rule 10b-5 does not have extraterritorial effect and the misreading of the decision by the lower courts.

Those courts holding that foreign securities are not subject to Section 10(b) leave a gaping hole in the US securities laws.  Under this line of reasoning, anyone selling foreign securities in the United States and closing the transaction in the United States could escape application of the antifraud provisions.

Apparently aware of this extreme position, some of the lower courts have tried to limit the damage by concluding that jurisdiction will apply to foreign securities if 'explicitly solicited by the issuer in the U.S.'  Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 2010 US Dist. Lexis 105720 (S.D.N.Y. Oct. 4, 2010) ; see also In re Societe Generale Sec. Litig., 2010 US Dist. Lexis 107719 (S.D.N.Y. Sept. 29, 2010) (defining domestic transactions as those 'explicitly solicited by the issuer within the United States rather than transactions in foreign-traded securities where the ultimate purchaser or seller has physically remained in the United States.') (quoting Stackhouse, 2010 US Dist. Lexis 76543).

Note first that there is no language in Morrison suggesting that jurisdiction turns upon the identity of the seller, much less on whether the transaction is a primary or secondary distribution.  Moreover, the clean test adopted by the Supreme Court (the location of the trade or the exchange traded nature of the security) has now become more complex and requires resort to the identity of the seller.  In effect, the court has added back into the analysis some of the facts that might have been examined under the discarded conducts/effects test.

The approach would allow unscrupulous sellers to conduct secondary market transactions inside the United States and not be subject to the antifraud provisions.  For example, if the issuer of securities in a ponzi scheme was set up overseas, the securities would be "foreign."  Apparently, everyone selling the securities except the issuer (and perhaps the issuer's affiliates) would find themselves exempt from the application of the antifraud provisions.  This is not what Congress intended in adopting Section 10(b) or the Supreme Court in deciding Morrison.

For primary materials on SEC v. Tourre, go to the DU Corporate Governance web site.  For primary materials on Morrison v. NAB, including the many amicus briefs filed in the case, go to the DU Corporate Governance web site.??

Full post as published by The Race to the Bottom on February 22, 2011 (boomark / email).