Morrison v. National Australia Bank: Protecting Foreign Shareholders and Discouraging Listings on the NYSE
J Robert Brown Jr. | Thursday, June 24, 2010 at 09:59AM The Supreme Court issued its opinion today in MORRISON ET AL. v. NATIONAL AUSTRALIA BANK. Not surprisingly, the Court held (in an opinion by Justice Scalia) that Rule 10b-5 had no extraterritorial effect. In resolving whether a company with headquarters in Florida could nonetheless be sued, the Court noted that "the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case."
The Court concluded that jurisdiction turned not on the location of the conduct but on the place where the securities were traded. "Applying the same mode of analysis here, we think that 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."
The Court's decision allowed it to conclude that fraudulent behavior occurring in the United States did not trigger liability under Rule 10b-5 where it did not involving trading in the US. In this case, all of the relevant trading by the plaintiffs occurred overseas (in Australia).
Nonetheless, the basis for the five Justice majority (three others concurred) is very troubling. By excluding the substantive behavior that causes the fraud as a basis for determining jurisdiction, the Court has generated questionable results.
First, the opinion indicates that in some cases, jurisdiction requires trading to occur in the United States. This means that US citizens who trade in US companies and allege fraud that occurred in the US lack jurisdiction under Rule 10b-5 if they bought the shares outside of the US. This is true even if an active (although as we will discuss, non-exchange) market exists in the US for the same shares.
Second, to avoid some of the obvious anomalous results created by the approach, the Court held that the requirement of domestic purchases did not apply to exchange traded companies. As the Court states: Rule 10b-5 extends to "transactions in securities listed on domestic exchanges, and domestic transactions in other securities". This suggests that as long as the relevant securities are listed, it doesn't matter where the trade occurs or the identity of the shareholders.
The result is that the Court has expanded jurisdiction for foreign shareholders and narrowed it for US shareholders.
Thus, it would seem that Japanese shareholders injured by fraud committed by Sony that occurred in Japan would have a cause of action in the US because Sony trades American Depositary Shares on the NYSE. On the other hand, a US shareholder injured by fraud that occurs in the United States in a company traded on the Bulletin Board (or anywhere else on the OTC market) will not have a cause of action if the shares sold in the US are purchased overseas (say in a private placement).
In other words, in an effort to deny jurisdiction in this case, the Court used an analysis that broadens the cause of action for foreign shareholders and narrows the cause of action for US shareholders. Moreover, it sends a strong strong message to foreign companies not to list their ADRs on the NYSE or the Nasdaq, thereby avoiding jurisdiction under Rule 10b-5. It also sends a strong message that shares sold by OTC companies should be marketed overseas, encouraging companies to send their business to foreign markets.
The anomolous results will likely result in efforts by lower courts to narrow the holding and find ways to allow US shareholders to bring actions under Rule 10b-5 even if purchasing the shares overseas, at least where the fraud occurs in the US.
Reader Comments (8)
More recent data indicates that in fact they are traded in the OTC. See http://www.nabgroup.com/0,,92857,00.html Perhaps the difference is timing. Maybe at the time the litigation was filed, the ADRs were traded on the NYSE but subsequently moved to the OTC. Either way, this adds to the confusion of the case. It suggests that ADRs listed on the NYSE are somehow not "securities registered on domestic exchanges". It is an entirely unexplained assertion and one that seems counter intuitive.
Actually, that was very surprising. No appellate court had held that before. Indeed, the Courts of Appeals have all held otherwise for decades.
"The Court concluded that jurisdiction turned not on the location of the conduct but on the place where the securities were traded."
No. The first section of the opinion explains that the issue was not one of jurisdiction but of whether a cause of action exists under the statute.
"The result is that the Court has expanded jurisdiction for foreign shareholders."
Completely wrong. The Court greatly narrowed the ability of foreign shareholders to bring suit. And, again, the issue is not one of jurisdiciton.
Re-read the case Mr. Brown.
But the Court seems to be saying that as long as the company's shares are traded on a national exchange, 10b-5 applies even if the trade does not occur in the United States. That begs the question as to what constitutes trading on an exchange. ADRs listed by the NYSE seem to be trading on an exchange but SCOTUS apparently doesn't think so.
The Court did not "extend" Rule 10b-5 to any exchange traded security (assuming you mean domestic exchange traded security). It's always been the law that purchasers, foreign or domestic, can bring a 10b-5 claim for purchases of securities traded on a domestic exchange. In fact, I would assume that every large 10b-5 class action ever brought has included some foreign investors.