Corporate Governance

Morrison, Tourre, and the Misguided Interpretation of Rule 10b-5 (The Lower Courts and The Misapplication of Section 10(b) (Part 4A)

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.

Lower courts have had to deal with a muddled Supreme Court opinion but they have also added to the confusion on their own accord.  Often uncomfortable with the logical implications of Morrison, the courts have substituted their own formulation for the one adopted by the Supreme Court.  In doing so, they have effectively adopted a reverse conducts and effects test. 

Some courts, for example, have largely ignored the domestic location of the transaction and concluded that Section 10(b) does not apply to the purchase or sale of a foreign security, even if the transaction takes place in the United States.  Thus, in Elliott Associates v. Porsche Automobil Holding SE, 2010 US Dist Lexis 138399 (S.D.N.Y. Dec. 30 2010), the court confronted a number of swaps executed in the United States that 'referenced' shares in Volkswagon.  The swaps did not result in the purchase of VW shares but were nonetheless valued based upon fluctuations in the shares of the German automaker.  Because the case did not involve shares traded on a US stock exchange, the only issue under Morrision was whether the 'sale' took place in the US.

Plaintiffs asserted that 'all steps necessary to transact the swap agreements' occurred inside the US.  Moreover, the agreements apparently contained a choice of law provision rendering New York law as controlling.  The court, however, ignored the location of the swap transaction and instead focused on the referenced security. Because the swap referenced a security traded on a foreign exchange, Section 10(b) did not apply.  See Id. ('Since the economic value of securities-based swap agreement is intrinsically tied to the value of the reference security, the nature of the reference security must play a role in determining whether a transnational swap agreement may be afforded the protection of Section 10(b).').   

Similarly, in In re Societe Generale Sec. Litig., 2010 US Dist. Lexis 107719 (S.D.N.Y. Sept. 29, 2010), the court concluded that shares traded on a foreign exchange were not subject to the antifraud provisions. See Id. ('Where, as here, domestic plaintiffs purchased shares of a foreign bank traded on a foreign exchange, the Exchange Act is inapplicable. . .').  The court suggested that to find otherwise would result in broad extraterritorial effect, something viewed as inconsistent with Morrison.  Id.  ('To do so would extend extraterritorial application of the Exchange Act's antifraud provisions to virtually any situation in which one party to a swap agreement is located in the United States.').  In other words, as long as the shares were listed on a foreign exchange, Section 10(b) was inapplicable even if the trade occurred in the United States.

In arriving at the same conclusion, the court in Plumbers' Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 2010 US Dist. Lexis 105720 (S.D.N.Y. Oct. 4, 2010) concluded that reliance on a test that looked to the location of the sale would result in a case-by-case approach in determining jurisdiction, something ostensibly viewed as inconsistent with Morrison.  Id.  ('The plaintiff's construction would require a fact-bound, case-by-case inquiry into when exactly an investor's purchase order became irrevocable.  It would also produce the regulatory multiplicity that the Supreme Court has directed courts to avoid.  Indeed, were plaintiffs' construction accepted, Morrison would have ‘upend[ed] a significant area of securities law,'').  

The Supreme Court, despite uneven language, did not exempt entirely foreign securities from the reach of Section 10(b).  Even these courts, as we will discuss in the next post, have been forced to limit their own reasoning. 

For primary materials on SEC v. Tourre, go to the DU Corporate Governance web site.  For primary materials in Morrison v. NAB, go to the DU Corporate Governance web site.?

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