As part of the Dodd-Frank Act, the Securities and Exchange Commission (SEC) was asked to solicit public comment and evaluate whether private litigants should be permitted to bring actions in the United States based on transnational securities frauds. In practical terms, the SEC was charged with examining whether the Supreme Court's Morrison decision, which limits Section 10(b) claims to domestic securities transactions, should be legislatively overturned or modified.
The SEC's study has been released and it contains a number of interesting items, including an analysis of the post-Morrison case law, a detailed review of the public comments, and a summary of the studies that have examined the capital markets impact of the Morrison decision. The SEC's overall conclusion, perhaps not surprisingly, is that the position it took in Morrison was correct as a matter of public policy (even if the Court rejected it on legal grounds). In Morrison, the SEC argued that the court should retain the preexisting conduct and effects tests for extending Section 10(b) private actions to transnational securities frauds, but limit the conduct test to situations where the plaintiff can demonstrate "that the plaintiff’s injury resulted directly from conduct within the United States." The SEC's approach arguably would have the benefit of "serv[ing] as a filter to exclude those claims that have a closer connection to another jurisdiction and, thus, are more appropriately pursued elsewhere." That said, the SEC also concedes that a more limited "conduct test" would still have the disadvantages of permitting "foreign investors [to] receive remedies that their governments have determined not to provide" and possibly "requiring a fact-intensive inquiry involving burdensome discovery. . . to determine if the alleged U.S. conduct constituted a direct cause of the overseas injury."
In response to these concerns, the SEC proposes a tweak and suggests alternatives for Congress to consider. The tweak is to make the conduct and effects tests available only to U.S. investors. While that still might require costly discovery to determine the scope and impact of the U.S. conduct, it alleviates some of the international comity problems created by allowing foreign investors, who engaged in foreign securities transactions, to bring suit in the U.S.
Alternatively, the SEC proposes that Congress "supplement and clarify" the Supreme Court's domestic transaction test in one or more of the following ways:
(1) Permit investors to bring Section 10(b) private actions based on transactions in any security that is of the same class of securities as those registered in the U.S., irrespective as to where the transaction took place. The idea is that companies who have registered shares in the U.S. have chosen to expose themselves to Section 10(b) liability, although the proposal also would have the obvious effect "of a return to U.S. courts of so-called “foreign-cubed” class actions – i.e., private class actions brought by foreign investors suing foreign issuers involving transactions on foreign exchanges."
(2) Create a Section 10(b) right of private action that can be brought "against: (i) securities intermediaries located within the United States when they defraud a client in connection with any securities transaction (i.e., foreign or domestic); and (ii) foreign securities intermediaries when they are reaching into the United States to provide securities investment services for a U.S. client and commit fraud against that client in connection with any securities transaction." The proposal is designed to close a "void" created by the domestic transaction test, wherein investment advisors can defraud their clients in connection with foreign securities transactions without fear of Section 10(b) liability.
(3) Create a "fraud-in-the-inducement" exception to the domestic transaction test, wherein investors can bring a Section 10(b) private action if they can demonstrate they were in the U.S. at the time they were induced to purchase or sell securities in reliance on a false or misleading statement, even if the transaction took place outside of the U.S. This proposal is another version of limiting the conduct test to U.S. investors, although the SEC suggests that it is narrower because the investors would need to demonstrate actual reliance, as opposed to basing their claims on a presumption of reliance created by the "fraud-on-the-market" theory.
(4) The Second Circuit recently clarified that a domestic securities transaction is one where "irrevocable liability was incurred or title was transferred within the United States." The SEC criticizes that approach, arguing that it may "serve as a roadmap for overseas fraudsters to structure transactions to avoid Section 10(b) private liability" by ensuring that key actions are taken outside of the country. Instead, the SEC suggests, Congress could "clarify that, in the case of off-exchange transactions, a domestic securities transaction occurs if a party to the transaction is in the United States either at the time that party made the offer to sell or purchase, or accepted the offer to sell or purchase."
But will Congress have any interest in pursuing a legislative reversal or modification of the domestic transaction test for Section 10(b) private action liability? Stay tuned.