Gillianne Tedder/Bloomberg News
The Supreme Court weighed in on a shareholder lawsuit asserting that National Australia Bank had made false statements about problems at its American mortgage subsidiary.
The Securities and Exchange Commission issued a report last week on whether investors should be able to pursue fraud claims on foreign securities transactions that take place outside the United States.
But given the current atmosphere that seems to view regulation as an unnecessary roadblock for businesses, the S.E.C’s report suggesting ways to expand the scope of the main antifraud provision of the federal securities laws is likely to be consigned to the trash bin.
Congress would have to adopt any changes the S.E.C. recommends, and it has not been friendly to the agency’s proposals since the enactment of the Dodd-Frank Act.
The S.E.C. was required by Congress to produce the report after the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd., issued just a few weeks after passage of the Dodd-Frank Act.
That case involved a shareholder lawsuit asserting that National Australia Bank had made false statements about problems at its American mortgage subsidiary. This was a so-called F-cubed case: foreign investors who bought shares of a foreign company through a foreign stock exchange, but were suing in the United States on the grounds that there was a violation of the United States’ antifraud law.
Lower courts had permitted such suits to go forward, ruling that cases could proceed if American investors were affected, or if any of the conduct took place in the United States. Such rulings, however, created uncertainty for foreign companies worried about being hauled into an American court.
But in its Morrison v. National Australia Bank ruling, the Supreme Court rejected such rationales. It instead adopted a narrower test, saying cases can be brought only if “the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.”
In adopting this approach, the Supreme Court said United States law could not be applied to actions abroad unless Congress made its intention clear that a law should apply to foreign conduct.
The court found that the antifraud statues should not be applied to foreign transactions, rejecting the argument that some connection to the United States was sufficient to allow for a claim under United States law.
Justice Scalia’s majority opinion rather playfully noted that “the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case.”
Unfortunately, the Morrison decision raised as many questions as it answered. For example, if a stock is listed on both an American and a foreign stock exchange, the right to bring a case could depend on which exchange the transaction took place, even though the investor may have no control over it. But if a foreign investor buys an American depositary receipt, which represents shares of a foreign company, on a United States exchange, then a fraud case might be available in a federal court.
Similarly, if the transaction occurs on a foreign exchange, then a foreign broker might not be liable for fraud even though the investor lived in the United States or the broker came to this country to meet with the client.
Another question arising from the Morrison decision was whether the Supreme Court’s test also applied to S.E.C. enforcement actions, a growing number of which involve foreign conduct. Congress dealt with that issue in the Dodd-Frank Act by adding a provision granting federal courts jurisdiction over S.E.C. cases when there was a “significant step” in the violation in the United States, or there was a “foreseeable substantial effect” in this country.
But Congress arguably even got that provision wrong when it provided for “jurisdiction” in the federal courts even though the Morrison opinion specifically found that they already had the power to hear a case, but that antifraud statutes did not reach foreign transactions. Whether the Congressional intent to allow the S.E.C. to pursue cases will overcome this glitch in the statutory language remains to be seen.
On the question of whether private investors should be able to pursue cases when the fraud involves foreign companies or trades on overseas stock exchanges, the Dodd-Frank Act avoided making a decision by directing the S.E.C. to conduct a study of the different tests that could be used. And this was not the only instance in which Congress avoided resolving an issue by asking for a study.
The latest S.E.C. study sketches out several approaches Congress could take to allow some foreign investors to sue in the United States for securities fraud. One possibility, which it also argued in its brief to the Supreme Court in the Morrison case, would give a right to pursue a case if some conduct in the United States directly caused harm to investors, regardless of where they bought the securities.
The S.E.C. also suggested that cases could be pursued as long as at least some of the fraudulent conduct occurred in the United States even if the trading took place in another country.
Unfortunately for the S.E.C., suggestions to allow for a greater number of lawsuits are unlikely to generate much support on Capitol Hill. Opponents are likely to say that more litigation means greater expenses for companies and encourages potentially frivolous claims. Add in the mantra that litigation costs jobs and makes companies fearful of going public, and any recommendation to tinker with the Supreme Court’s narrow test for securities fraud is likely to fall on deaf ears.