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In Morrison v. National Australia Bank, Ltd., 561 U.S. 247 (2010) the Supreme Court held that the reach of Exchange Act Section 10(b) is the water’s edge of the United States [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance]. Specifically, the court held that the Section only provides a cause of action if the purchase or sale of the security took place on a U.S. exchange or within the United States. The decision is based on a presumption that legislation has no extraterritorial reach absent an express Congressional intent to the contrary. Since the Exchange Act lacks any such expression Section 10(b)’s reach is limited by its focus – the location of the purchase or sale of the security.
Subsequently, Morrison has been followed in a series of Section 10(b) actions. The Second Circuit has also applied its teachings to RICO and the Commodity Exchange Act. In contrast, the Sixth Circuit, concluded that Morrison does not apply to another securities statute – Section 206 of the Investment Advisers Act. Lay v. U.S., Case No. 13-4021 (6th Cir. August 17, 2015) [lexis.com | Lexis Advance].
Defendant Mark Lay was convicted of investment adviser fraud and on counts of wire fraud related to investments he made for the Ohio Bureau of Workers’ Compensation. Mr. Lay found MDL Capital Management, Inc. The firm became an SEC registered investment adviser.
One of the firm’s clients was the Ohio Bureau of Workers’ Compensation. That agency assists Ohio based employers and employees with expenses tied to work place injuries. For years Mr. Lay and his firm managed the Bureau’s funds in a U.S. based fund. Investments were primarily in U.S. long term treasury bonds. The fund made money.
Subsequently, Mr. Lay founded an “offshore” hedge fund in Bermuda. MDL Capital was its adviser, although there was no specific advisory agreement between the Bermuda fund and MDL. The investments of the Bureau were managed in both funds.
At one point Mr. Lay and MDL began leveraging the Bermuda fund. This was contrary to the agreement with the Bureau who was not informed. Losses were incurred. Rather than inform the fund, Mr. Lay and MDL sought permission to use leverage. It was denied. Eventually the Bureau learned of the leverage and the concealed losses. The agency withdrew its funds. Only $9 million of its $225 million investment was returned.
The District Court rejected Mr. Lay’s claim that Morrison compelled dismissal of the Section 206 charge. The Circuit Court agreed: “The problem with defendant’s argument is two-fold: (1) the Securities Exchange Act and the Investment Advisers Act seek to regulate different aspects of securities transactions, and (2) unlike Morrison, the only aspect of this case not tied to the United States is that the fund in question is based in Bermuda. All other aspects of the case are centered in the United States.”
The Advisers Act regulates person and entities who advise others on securities investments. Those persons register with the SEC and have fiduciary duties to their clients. Those include good faith, loyalty and fair dealing, the Court noted. In contrast, the Exchange Act does not specifically “prescribe a stand of conduct for investment advisers.” In addition, here virtually all of the conduct is domestic, unlike Morrison.
Finally, the focus of the Advisers Act is the prevention of wrongful practices by the adviser, the Court determined. This contrasts sharply with the Exchange Act which is centered on the purchase or sale of a security. According, the court concluded that Morrison does not apply to Section 206 of the Advisers Act.
For more news and commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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