Morrison, Jurisdiction and the Uncomfortable Results of the Supreme Court's Analysis (Part 4)

Morrison addressed jurisdiction over actions under Rule 10b-5.  The Court required that the relevant security be traded on a US stock exchange or that the transaction occur in the US.  The Court did not deal with other antifraud provisions, particularly Section 17(a) of the Securities Act of 1933.  That provision largely duplicates Rule 10b-5 except that it applies not just to sales but also to offers.  

The applicability of Morrison came up in SEC v. Tourre, the surviving remnant of the case brought against Goldman Sachs.  Tourre sought dismissal of the action against him on the grounds that many of the claims were precluded by the analysis in Morrison.  The court agreed with respect to the claims brought under Rule 10b-5.  The SEC did not allege that the relevant investors had assumed "irrevocable liability" in the US.  Instead the Commission sought to establish jurisdiction by showing that "the entire selling process" had taken place in the US.  Such activity was not, however, enough under Morrison to establish the application of Rule 10b-5.

• The shortcoming of all of this U.S.-based conduct is precisely that—it is just conduct. Morrison was clear that domestic conduct is not the test for determining Section 10(b) liability.  130 S. Ct. at 2884 (explaining "the focus of the Exchange Act is not upon the place where the deception originated, but upon purchases and sales of securities in the United States" and that "Section 10(b) does not punish deceptive conduct, but only deceptive conduct 'in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered'").

The claims under Section 17(a), however, were treated differently.  Essentially, Tourre argued that the antifraud provisions in the 1933 Act should have no greater geographical reach than those in the Exchange Act.  The court disagreed.   

• Tourre argues that the SEC's allegation that Goldman offered ABACUS securities to IKB from the United States is irrelevant because IKB is based in Germany. In effect, Tourre's argument is that an "offer," even if made in the United States, is not domestic if it is made to a foreign party. Nothing in the definition of "offer," however, indicates that the focus of that term, for purposes of Section 17(a) liability, is on the recipient. To the contrary, the Securities Act defines an "offer" to "include every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value." 15 U.S.C. 77b(a)(3).  This definition leaves no doubt that the focus of "offer," under the Securities Act, is on the person or entity "attempt[ing] or offer[ing] to dispose of" or "solicit[ing] . . . an offer to buy" securities or security-based swaps. Id.

To adequately establish jurisdiction, the SEC had to allege an "(1) 'attempt or offer[,]' in the United States, 'to dispose of' securities or security-based swaps or (2) 'solicit[,]' in the United States, 'an offer to buy' securities or security-based swaps."  The court found that the SEC met this pleading standard.

• Here, the SEC alleges Tourre, acting in and from New York City, offered ABACUS notes to IKB and solicited ABN's participation in an ABACUS CDS via direct and indirect communications. These communications included phone calls Tourre participated in from New York City and/or emails he sent from New York City to IKB and ABN regarding ABACUS and constituted domestic "offers" of securities or security-based swaps.  In these communications, the SEC alleges, Tourre knowingly, recklessly, or negligently failed to disclose Paulson's involvement in the portfolio selection process.  In view of these allegations, the SEC sufficiently alleges Tourre violated Section 17(a) with respect to IKB and ABN. 

Behavior short of an actual sale will not, therefore, be subject to Rule 10b-5 but can easily be subject to Section 17(a).  This increases the category of foreign companies with exposure in the US and increases the "probability of incompatibility with the applicable laws of other countries".

The consequence of the decision is to force the SEC to make greater use of Section 17(a) when bringing actions against foreign issuers.  One consequence is that the SEC will bring actions under a Section that requires a lower state of mind.  Unlike Rule 10b-5, Section 17(a)(2) and (a)(3) do not require scienter; negligence will suffice. 

Tourre has filed a motion for reconsideration.  For primary materials on this case, including the motion for reconsideration, go to the DU Corporate Governance web site.