Extra, Extra! – Extraterritoriality And Criminal Actions As To Alleged Securities Fraud

In its seminal decision in Morrison v. National Australia Bank Ltd., 130 S. Ct. 2869 (2010), regarding antifraud provisions of the U.S. securities laws, the Supreme Court held that “Section 10(b) [of the Securities Exchange Act of 1934] reaches the use of a manipulative or deceptive device or contrivance only in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”  Id. at 2888.  Although Morrison—which involved a private action by foreign plaintiffs—appeared to set down a bright-line rule, it spurred a number of questions, including whether its holding would apply beyond the private civil context, to SEC civil enforcement actions and criminal prosecutions as well.  A large number of courts have already applied Morrison to SEC actions.  In a recent significant development, the Court of Appeals for the Second Circuit concluded that Morrison also applies to criminal cases brought pursuant to Section 10(b) and Rule 10b–5.  United States v. Vilar, Case No. 10-521, at *3 (2d Cir. Aug. 30, 2013).  But the Dodd-Frank Act’s “extraterritorial jurisdiction” amendment to the Exchange Act for actions brought by the SEC and the DOJ—the immediate congressional response to Morrison—will presumably be invoked by the government for actions based on post-amendment conduct.

In his concurrence with the Court’s opinion in Morrison, Justice Stevens noted that, although the Court’s rule would “foreclose private parties from bringing § 10(b) actions whenever the relevant securities were purchased or sold abroad and are not listed on a domestic exchange,” the opinion did not “foreclose the Commission from bringing enforcement actions in additional circumstances.”  Morrison, 130 S. Ct. 2869 at 2894 & n.12 (Stevens, J., concurring).  Yet lower courts across the country have repeatedly applied Morrison to civil SEC enforcement actions.

Until recently, however, the question of whether Morrison applies with respect to criminal prosecutions under the federal securities laws had not yet been addressed head-on by a court.  In Vilar, the government argued that, at most, “Morrison’s geographic limit on the reach of Section 10(b) and Rule 10b–5 applies only in the civil context,” not the criminal one.  Vilar, Case No. 10-521, at *9.  The Second Circuit unequivocally disagreed.  Id.  The Vilar court held that “the general rule is that the presumption against extraterritoriality applies to criminal statutes, and Section 10(b) is no exception.”  Id. at *15.  Furthermore, the Second Circuit stated that, beyond the presumption, “[a] statute either applies extraterritorially or it does not,” and the Supreme Court had already ruled on that issue as to Section 10(b) in Morrison.  Id. at *15-*17.  The Vilar court rejected the government’s arguments that “Section 10(b) is interpreted differently in the criminal and civil contexts because different elements are required to prevail in each,” concluding that “none of these differences relate to the conduct proscribed by Section 10(b).”  Id. at *16 (emphasis in original).

The Second Circuit affirmed the criminal convictions of Alberto Vilar and Gary Tanaka, however, after finding that the record in the case “confirm[ed] that [they] perpetrated fraud in connection with domestic securities transactions.”  Id. at *4.  The Second Circuit relied on an earlier decision, post-Morrison, articulating that “a securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.”  Id. at *19 (quoting Absolute Activist Value Master Fund Ltd. v. Ficeto, 677 F.3d 60, 69 (2d Cir. 2012)) (internal quotation marks omitted).  The test for whether a securities transaction is “domestic” for purposes of Section 10(b), under Morrison and Absolute Activist, also features prominently in other high-profile securities litigation such as the SEC’s action against Fabrice Tourre.  In Vilar, as summarized by the appellate court, “a jury found that Vilar and Tanaka lied to clients about the nature and quality of certain investments,” id. at *3, and the key evidence for Morrison purposes was that—although the securities were not listed on an American exchange and the defendants engaged in various foreign conduct in connection with the alleged fraud—one set of victims signed and renewed an agreement with Vilar and Tanaka in Puerto Rico, another did so in New York, and a third executed certain documents necessary for the investment in New York as well.  Id. at *19-20.

In holding that such evidence was sufficient to pass muster under Morrison, the Second Circuit differed from the district judge’s conclusion in the civil action brought against Vilar and Tanaka by the SEC.  Id. at n. 11.  There, the judge, in applying Morrison, granted summary judgment to the SEC as to the New York transaction, but denied summary judgment on the securities fraud claims as to the Puerto Rico transaction because Vilar may have sent an offer letter from abroad and, under Puerto Rico law, a contract agreed to by mail might be considered to be executed at the place where the offer was made.  Id. (citing S.E.C. v. Amerindo Inv. Advisors, Inc., Case No. 05 CIV. 5231, 2013 WL 1385013, at *6-*8 (S.D.N.Y. Mar. 11, 2013)).  The Second Circuit held that “territoriality under Morrison concerns where, physically, the purchaser or seller committed him or herself, not where, as a matter of law, a contract is said to have been executed.”  Id.  However, the appellate court noted that a number of other factors were not sufficient to establish territoriality, including that the investments were marketed in the United States and sold to customers based in the United States, investors were instructed to wire funds to a bank in New York, and the custodian of the fund was a New York securities firm.  Id. at n.10.

Ultimately, however, any assessment of the impact of Vilar, and any other decisions that may follow the Second Circuit’s lead, must contend with the Dodd-Frank Act, which was signed into law less than a month after Morrison was handed down.  Section 929P of the Dodd-Frank Act amended the Securities Exchange Act of 1934 by adding a new section entitled “Extraterritorial Jurisdiction.”  This addition states that federal district courts shall have jurisdiction over actions brought by the SEC or the United States alleging a violation of the antifraud provisions of the Exchange Act involving “(1) conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.”  Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 § 929P(b)(1), Pub.L. No. 111–203, 124 Stat. 1376, 1864 (2010) (codified at 15 U.S.C. § 77v(c)).  The Second Circuit’s Vilar decision—which involves alleged conduct and criminal convictions entered prior to this amendment—does not address the statutory change.  In the SEC v. Tourre action—when addressing motions for summary judgment focusing on whether alleged events that took place in the United States were sufficient to render any fraud that occurred actionable under Section 10(b) and Rule 10b–5—the district court noted that, “[b]ecause the Dodd-Frank Act effectively reversed Morrison in the context of SEC enforcement actions, the primary holdings of this opinion affect only pre-Dodd Frank conduct.”  S.E.C. v. Tourre, Case No. 10 CIV. 3229, 2013 WL 2407172, at *1 & n.4 (S.D.N.Y. June 4, 2013).  But questions abound as to the meaning and scope of Section 929P, which will be worked out in the courts.  As one interesting recent example: In S.E.C. v. Chicago Convention Ctr., LLC, Case No. 13 C 982, 2013 WL 4012638 (N.D. Ill. Aug. 6, 2013), the parties directly pitted Morrison against the Dodd-Frank provision.  The defendants argued that, “under the ‘transactional’ test set forth in Morrison, the SEC cannot assert a claim against them because the transactions at issue here were not ‘domestic transactions’”; the SEC, on the other hand, argued that Dodd-Frank “superseded Morrison and revived the previously applied ‘conducts and effects’ test for SEC actions.”  Id. at *2.  The district court—noting that “whether the ‘transactional’ test or the ‘conducts and effects’ test governs this suit” was “a complicated question”—concluded that it did not need to resolve it “because the SEC has stated a claim under either inquiry.”  Id.  But courts will likely need to grapple with and resolve issues surrounding Section 10(b) stemming both from Morrison and the Dodd-Frank Act.