THE REACH OF SECTION 10(b): THE SUPREME COURT AND FOREIGN-CUBED

The Supreme Court agreed to hear the Second Circuit’s “foreign-cubed” decision, Morrison v. National Australia Bank Ltd., Case No. 08-1191. In that case, the circuit court affirmed the dismissal of a securities fraud complaint for lack of jurisdiction, as discussed here. The decision by the Supreme Court could have a significant impact on the reach of the antifraud provisions of the federal securities laws.

Morrison is a securities class action involving the claimed manipulation of the internal books of the U.S. subsidiary of an Australian public company whose ADRs are traded in New York. Respondent National Australia Bank is an Australian company headquartered in Melbourne, Australia. In 1998, the bank acquired Jacksonville, Florida based HomeSide Lending, Inc. Petitioners are non-U.S. shareholders of the bank.

The complaint claims that the defendant Respondents. which includes the bank, HomeSide and certain officers and directors, made false and misleading statements that inflated the price of the bank’s shares. The false statements stem from the claimed manipulation from 1998 to 2001 of the value of HomeSide’s mortgage portfolio. False values for that portfolio were furnished to the bank, whose CEO knew of the manipulation, but permitted the numbers to be incorporated into the public financial statements of the bank. Later, following significant write downs of the mortgage portfolio, the share price dropped significantly.

The court of appeals stated that there are two basic tests to determine whether there is jurisdiction over a suit such as this. First, the conduct test looks to determine whether the wrongful conduct occurred in the United States. Second, the effects test focuses on whether the conduct had substantial effects in the U.S. or on its citizens.

Here, the Second Circuit focused on the conduct at the heart of the claimed fraud. The court concluded that the actions taken and not taken by the bank in Australia were significantly more central to the fraud and more directly responsible for the harm to investors than the manipulation in Florida. In addition, the court concluded that the connection between any misconduct in the United States and the injury petitioners claimed to have suffered is too attenuated. In reaching its conclusion, the court emphasized that there is no allegation of fraud impacting U.S. investors or capital markets.

The Solicitor General, appearing as amicus curiae in a brief with the SEC, urged the high court not to take the case. The solicitor argued that the Second Circuit was correct. At the same time, the brief for the government notes that the Second Circuit, along with others, erroneously concluded that the issue in these cases is jurisdictional. Courts have then considered policy factors to determine if they have jurisdiction since the Exchange Act does not specifically address transnational transactions.

The question in foreign-cubed cases is not jurisdiction, the Solicitor argued. Under the Exchange Act, courts have jurisdiction over actions arising under the statute. Thus, the question is one of statutory construction and whether the conduct falls with the ambit of the statute. Here, the conduct described violates Section 10(b) but the link between the U.S. component of the scheme and Petitioner’s injury is too attenuated to support a private suit. This argument echoes the approach used in part by the Supreme Court in Stoneridge, discussed here. There, the Court focused in part on the reliance element of a damage cause of action to reject arguments about scheme liability without delimiting the reach of Section 10(b) which could impact SEC enforcement cases.

In a footnote, the Solicitor stated that, although the SEC supported Petitioner’s in the circuit court, that was based on existing Second Circuit precedent. Now the SEC has joined the position of the Solicitor.

The Supreme Court’s decision in this case may resolve the transnational reach of the antifraud provisions of the securities laws unless the approach argued by the Solicitor is invoked. That same question however, is pending in Congress. H.R. 3817, The Investor Protection Act of 2009, incorporates the two-part Second Circuit test in Section 215. Accordingly, next year there may be a resolution of a significant issue regarding the ultimate reach of Section 10(b).