Morrison, Jurisdiction and the Uncomfortable Results of the Supreme Court's Analysis (Part 1)

As we have noted on this Blog, the Supreme Court in Morrison v. NAB adopted an uncomfortable test for determining when courts have jurisdiction over securities fraud suits involving foreign issuers. The Court wanted to limit the impact of Rule 10b-5 on these issuers but did so with a test that produced anomalous results. 

In an effort to do away with the fact specific "conduct and effects" test, the Court shifted the focus away from the actual fraud and replaced it with an emphasis on the type of security involved or the the location of the transaction.  The Court held that Rule 10b-5 gave courts jurisdiction over securities traded on a US exchange and over transactions that occurred in the United States. 

With the location of the fraud rendered irrelevant, the test allowed for securities fraud to be conducted entirely within the borders of the US but to avoid applicability of Rule 10b-5 so long as the security was not traded on an exchange and the actual transaction took place elsewhere.  Imagine a ponzi scheme occuring in the US but where the final sales pitch and transaction takes place at a resort in Mexico.  The SEC has indicated concern with this type of manipulation of the antifraud provisions, but it is allowed under the Supreme Court's reasoning.  See SEC v. Goldman Sachs, 2011 U.S. Dist. LEXIS 62487 (SD NY June 10, 2011) (“In response, at oral argument, the SEC argued that U.S. companies should not be allowed to skirt U.S. federal securities laws by using foreign affiliates to complete securities transactions. Justice Stevens voiced similar concerns in a concurring opinion in Morrison.”). 

The holding also did not accomplish its central goal of excluding foreign issuers from the reach of Rule 10b-5.  With the analysis focused on the location of the transaction, the Court left open the possibility that jurisdiction would arise where the company and shareholders were foreign, the fraud took place entirely overseas, but the sale actually occurred in the US.  How might this occur?  An investor could insist that the transaction take place in the US solely to ensure attachment of the federal antifraud provisions. 

Perhaps because of the disconnection between the goal and the test, the federal courts in New York have struggled with the standard.  They have tended to exempt transactions in foreign companies even if the sale occured in the United States.  Thus, one court found a lack of jurisdiction for transactions in ADRs where the sales took place in the US. 

In fact, this very possibility has occurred.  We will discuss the case in the next post.

In this case, there is no dispute that the Templeton stock was not listed on a

domestic stock exchange, and so the only issue under Morrison is whether the

“purchase or sale” occurred in the United States.