Key issues
On 24 June 2010, the Supreme Court of the United States handed down a decision of wide-reaching importance in Morrison v National Australia Bank. The decision provides non-United States companies with greater clarity as to the extra-territorial scope of the Securities and Exchange Act of 1934 (SEC Act), the United States’ federal securities legislation, and the potential for claims to be brought against such companies in United States courts.
The case is significant for non-United States companies because the Supreme Court considered for the first time the extra-territorial application of anti-fraud provisions in the SEC Act to a claim in which virtually all elements were ‘foreign’ to the United States, namely, a non-United States plaintiff was bringing a claim against a non-United states respondent company in respect of securities listed on a non-United States securities exchange.
In its decision, the Supreme Court severely restricted the extra-territorial application of the SEC Act. The decision provides non-United States companies with clear guidelines as to how to structure the issue of securities so as to avoid potential SEC Act liability.
Facts
National Australia Bank (NAB) is a bank incorporated in Australia and whose ‘ordinary shares’ are traded on the Australian Stock Exchange and other foreign securities exchanges, but not on any exchange in the United States.
In 1998, NAB purchased HomeSide Lending (HomeSide), a company headquartered in Florida, United States, that was in the business of servicing mortgages.
From 1998 to 2001, NAB’s annual reports and other documents promoted the success of HomeSide’s business.
In 2001, NAB had to write down the value of HomeSide’s assets, causing NAB’s share price to fall.
The plaintiffs, Australian residents, who purchased NAB’s ordinary shares outside the United States before the write-down, sued NAB, HomeSide and officers of both companies in a United States District Court for alleged violations of the principal anti-fraud provisions in the SEC Act—§§10(b) and 20(a). The plaintiffs claimed that HomeSide and its officers had manipulated financial models to make the company’s mortgage-servicing rights appear more valuable than they really were and that NAB and its officers were aware of this deception.
The US District Court dismissed the claims for lack of subject matter jurisdiction and for failure to state a claim on the basis that the claim had an insufficient link to the United States. The Court of Appeals for the Second Circuit affirmed the decision on similar grounds.
The Supreme Court’s decision
The Supreme Court affirmed the Court of Appeal’s dismissal of the case but disagreed with the court’s reasoning.
Over a period of many decades, various US Courts of Appeal, when determining the extraterritorial application of the SEC Act and §10(b) in particular, to fraudulent schemes that involved conduct and effects outside the United States adopted two tests:
- whether the wrongful conduct occurred in the United States – ‘conduct’ test, and
- whether the wrongful conduct had a substantial effect in the United States or upon United States citizens – ‘effects’ test.
The Supreme Court noted the unpredictable and inconsistent application of §10(b) to transnational cases that resulted from the application of these tests. The Supreme Court rejected these tests and stated that the correct approach to determining the scope and application of §10(b) is to identify what conduct §10(b) prohibits. In determining whether or not §10(b) had extra-territorial application, the Supreme Court applied the longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.
The Supreme Court found no affirmative indication in the SEC Act that §10(b) applies extraterritorially and accordingly concluded that it did not. The Supreme Court held that the focus of the SEC Act is not upon the place where the deception originated, but upon the purchases and sales of securities in the United States. Section 10(b) does not punish deceptive conduct, but only deceptive conduct in connection with the purchase or sale of any security registered on a United States securities exchange or the purchase or sale of any other security in the United States.
The Supreme Court noted that the adoption of such a test would assist in avoiding the consequence that the SEC Act would interfere with foreign securities regulation
Applying the test, the Supreme Court held that the case involved no securities listed on a United States securities exchange and all aspects of the purchases by the plaintiffs occurred outside the United States. Accordingly, the plaintiffs failed to state a claim for which relief can be granted and the claim was dismissed.
Looking forward
The case has potentially significant and far-reaching implications for non-United States companies. The test propounded by the Supreme Court will make it very difficult for shareholders to bring claims that relate to the purchase or sale of securities outside the United States.
Where securities are purchased outside the United States, for example, when not-listed on a US exchange, it is possible that non-United States companies avoid potential SEC liability for international securities transactions.
For that reason, United States investors may seek to insist that securities are issued in such a manner that the SEC Act would be applicable to the sale.
This article was written by Leon Chung, Senior Associate, Sydney.
More information
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