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The focus of SEC enforcement in the coming months is a
function of its constricted and later expanded authority. Last year that
authority contracted in the wake of the Supreme Court's decision in Morrison
v. National Australia Bank Ltd., 130 S.Ct. 2869(2010). Later congress
effectively overruled Morrison as to the SEC and DOJ and expanded their
authority. A warning from the SEC in a Section 21(a) report in view of the
congressional action may suggest a key focus for SEC enforcement in the future.
In Morrison the Supreme Court agreed with the
Second Circuit that a shareholder suit based on Exchange Act Section 10(b)
should be dismissed. The complaint had been brought by Australian shareholders
of the bank. It alleged fraud based largely on transactions which occurred in
the U.S. subsidiary that impacted the books and records of the parent company
and thus the share price on the Australian exchange. The district court
dismissed the complaint for lack of jurisdiction based on long standing Second
Circuit jurisprudence which has been largely followed in other circuits.
While the Supreme Court agreed that the case was properly
dismissed, it differed as to the rationale. Justice Scalia, writing for the
Court, began by noting that the question to be resolved is not one concerning
the authority of the district court to hear the case. The Exchange Act confers
jurisdiction on the court to hear a securities fraud suit. Rather, the issue is
whether the conduct is within the scope of Section 10(b).
In this case that question centers on whether Section
10(b) has extraterritorial reach. When considering if a U.S. statute has
extraterritorial reach, the beginning point is the long standing presumption
that legislation by Congress is meant to apply only within the territorial
jurisdiction of the U.S. unless there is a contrary intent according to the
Court. Here there is none. Accordingly, Section 10(b) is limited to conduct
which occurs on U.S. exchanges and within the country.
Since Morrison delimited the reach of Section 10(b) it
impacts not only private damage actions but also SEC enforcement cases. The
immediate result of the decision is to limit the reach of SEC enforcement. This
point is illustrated by the Moody's Investor Services, Inc. Section 21(a)
Report. Exchange Act Release No. 62802 (Aug. 31, 2010).
The Report arises out of an enforcement investigation
which centered on a new model the firm developed to rate constant proportion
debt obligations or CPDOs, a kind of special purpose vehicle marketed in
Europe. After rating the instruments the firm discovered an error in the metrics.
The firm chose not to acknowledge the error until after a May 2008 Financial
Times article exposed it. By that point however Moody's had registered with
the SEC as a NRSRO. In its registration papers the firm detailed its core
principles which were not followed when rating the CPDOs.
The Commission declined to bring an enforcement action,
citing uncertainty regarding its jurisdiction. While the Report does not cite Morrison,
it seems clear that the Court's ruling influenced the prosecutorial decision.
The Release however concludes with a warning that in the
future such conduct may result in an enforcement action: "The Commission notes
that, in recently enacted legislation, Congress has provided expressly that
federal district courts have jurisdiction over Commission enforcement actions
alleging violations of the antifraud provisions . . . involving 'conduct within
the United States that constitutes significant steps in furtherance of the
violation, even if the securities transaction occurs outside the United States
that has a foreseeable substantial effect within the United States.'"
The Commission's warning that in the future it will
scrutinize conduct is the international markets is well grounded. Dodd-Frank
effectively overruled Morrison as to the SEC and the Department of
Justice, giving both additional enforcement authority and perhaps a mandate.
Specifically, the Act provides that the antifraud provisions extend in SEC and
DOJ actions to any conduct within the U.S. that constitutes "significant steps
in furtherance of the violation" even where the securities transaction is not
in the U.S. and involves only foreign investors. The extension also covers any
conduct outside the US. that has a foreseeable, substantial effect in the
Morrison, the Moody's Report and Dodd-Frank give
definition to the scope of SEC enforcement in the near and far term.
Enforcement actions stemming from pre-Morrison conduct will be limited by the
Supreme Court's decision as the Moody's Report makes clear. In contrast,
investigations and cases based on post-Dodd-Frank conduct may have the broader,
more international reach consistent with the authority give to the agency by
the Congress as the Moody's Report warns.
Next: SEC Enforcement in court
For more cutting edge commentary on
developing securities issues, visit SEC Actions, a blog
by Thomas Gorman.