SEC Releases Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Exchange Act

This is an update to our November 30, 2010 and April 26, 2011 blog posts relating to the SEC's Study on Extraterritorial Private Rights of Action.  The study was a result of the Supreme Court's decision in Morrison v. National Australia Bank, 130 S. Ct. 2869 (2010), which abandoned nearly 50 years worth of legal precedents, limiting the ability of Americans to invoke the protections of the U.S. securities laws against transnational securities fraud.  Specifically, the Supreme Court rejected the U.S. Second Circuit Court of Appeal's "conducts and effects" test and established a transaction based test focusing on the location of the purchase or sale of the securities. The new bright line test limits Section 10(b) claims to the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.

Shortly after Morrison was decided, the Dodd-Frank Act was enacted, which restored the ability of the SEC and DOJ to bring enforcement actions for securities fraud if the matter involves: "(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States."  Although the Act did not provide the same protections for private citizens, Section 929Y directed the SEC to conduct a study to determine whether private rights of action should be extended to the same extent as that provided to the SEC and DOJ.

On April 11, 2012, the SEC released its "Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934."  A copy of the 73 page report can be found here.  In response to the SEC's request for public comments, the SEC received 72 comment letters (30 from institutional investors; 19 from law firms and accounting firms; 8 from foreign governments; 7 from public companies and associations representing them; 7 from academics; and 1 from an individual investor). Of these, 44 supported enactment of the conduct and effects tests or some modified version of the tests, while 23 supported retention of the Morrison transactional test.

In the study, the SEC does not take any position on the question of whether or not Congress should pass legislation to overturn Morrison.  Instead, the SEC presents several options for Congress to consider, including (1) enactment of the "conduct and effects" tests; (2) narrowing the conduct test's scope to require the plaintiff to demonstrate that his/her injury resulted directly from conduct within the United States; (3) enacting the conduct and effects tests only for U.S. resident investors; (4) clarifying the transaction test by permitting investors to pursue a Section 10(b) claim for the purchase or sale of any security that is of the same class of securities registered in the United States, irrespective of the actual location of the transaction; (5) authorizing Section 10(b) private actions against securities intermediaries such as broker-dealers and investment advisers that engage in securities fraud while purchasing or selling securities overseas for U.S. investors or providing other services related to overseas securities transactions to U.S. investors; (6) permitting investors to pursue a Section 10(b) private action if they can demonstrate that they were fraudulently induced while in the United States to engage in the transaction, irrespective of where the actual transaction takes place; and (7) clarifying that an off-exchange transaction takes place in the United States if either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the United States.

In connection with the release of the study, Commissioner Luis A. Aguilar issued a harsh dissenting statement relating to the SEC's report. As part of a press release entitled, "Defrauded Investors Deserve Their Day in Court," Mr. Aguilar recommended that Congress enact for private litigants a standard that is identical to the standard set forth in Section 929P of the Dodd-Frank Act - the standard for SEC and DOJ actions:

Today the Commission has authorized that a Study be sent to Congress expressing the views of the Staff on the cross-border scope of the private right of action under Section 10(b) of the Securities Exchange Act of 1934. However, my conscience compels me to write separately to record my views on the Study. I write to convey my strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result, due to Morrison v. National Australia Bank, Ltd

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If American investors are defrauded by a company that they have invested in - and that company is listed on a foreign exchange - investors may be unable to have their day in court and seek redress against this company for its lies and misrepresentations. Thus, investors have been stripped of a traditional American right.

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The answer to the Congressional query about whether to re-establish extraterritorial private rights of action under Section 10(b) of the Exchange Act through the application of the pre-Morrison tests of conduct and effect is an unequivocal yes.

The Study is incomplete in many ways, but I will just highlight the following:

• It Fails to Adequately Explain how Private Rights of Action are a Vital Complement to SEC Actions and Essential to Investor Protection;
• It Overstates the International Comity Concerns Associated with Restoring Investors' Rights to Assert Private Claims Under Section 10(b);
• It Does Not Accurately Portray Investor Harm Resulting from Morrison and Fails to Convey a Sense of Urgency as to the Harm Being Suffered; and
• It Provides as an Option That Congress Take No Action at All Despite the Continuing Harm to Investors.

The Study should have recommended that Congress enact for private litigants a standard that is identical to the standard set forth in Section 929P of the Dodd-Frank Act - the standard for SEC and DOJ actions. The harm that has resulted and continues to result to investors is significant, and Congress should act to rectify this with haste.

Abbey Spanier Rodd & Abrams, LLP, located in New York City, is a well-recognized national class action and complex litigation law firm.

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