SEC Prevails in First Circuit
The question of extraterritorial reach under Section 10(b) was resolved by the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010). There the Court concluded that the federal securities laws do not apply to extraterritorial transactions. Rather, the statutes apply to transactions that occur on domestic exchanges and to domestic transactions. The latter occur when the focus of the transaction in the U.S. For Exchange Act Section 10(b) that is where the purchase or sale of the security takes places. Since Morrison was decided Congresses amended the statute, adding a new conduct-and-effects test which governs the questions. Nevertheless, the First Circuit confronted a question about the reach of Section 10(b) in SEC v. Morrone, No. 19-2007 (1st Cir. Decided May 10, 2021).
Morrone centers on an offering fraud in an action brought by the Commission, alleging violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). Bio Defense Corporation is a Massachusetts based firm created by Michael Lu in 2001. The firm was a response to the widely publicized mailing of letters containing anthrax following the September 11, 2001 terrorist attacks. Defendants in the action also conclude Jonathan Morrone, Anthony Orth, Paul Jurberg and his firm Brookline Capital and Brett Hamburger.
Over a four-year period, beginning in 2004, the firm and its members encountered regulatory difficulties in marketing Bio Defense shares – none of its member were registered brokers. First, in 2007 the firm and Messrs. Lu, Morrone and Jurberg consented to the entry of cease-and-desist orders issued by the Texas State Securities Board. The next year securities regulators in Massachusetts opened an investigation. Bio Defense, on the advice of counsel, decided to stop selling securities to U.S. based investors.
The next year the group decided to work with Agile Consulting, a firm that ran call centers targeting investors in Europe. The difficulty was the fee – it was 75% of the proceedings. Despite the high commissions, the deal was made – solicitations would be through Agile in what was latter dubbed the “EU Project.”
The documents used at the call centers for the investor pitch were generated in the U.S. by Messrs. Morrone and Jurberg. When an investor entered into an agreement with Bio Defense after hearing the sales pitch from the call center, the agreement was forwarded to either Defendant Morrone or Mr. Jurberg in Boston. There the documents were counter-signed. A Bio Defense stock certificate was mailed from Boston to the investors. The fees were paid. Bio Defense entered into other, similar arrangements, that required the payment of fees ranging from 70% to 75%. The district court held in favor of the Commission on a motion for summary judgment on the Section 10(b). The Circuit Court affirmed.
Appellants argued that the Supreme Court’s decision in Morrison was misapplied in this case – the transactions were outside the reach of Section 10(b) since they occurred in Europe. The First Circuit had not previously considered the application of Morrison in a securities fraud suit. Other circuits, however, “have held that a transaction is domestic under Morrison if ‘irrevocable liability’ occurs in the United States.” This happens when the purchaser incurs irrevocable liability in the U.S. That standard has been adopted by the Second, Third and Ninth Circuits.
Here the Court adopted the standard of those Circuit Courts. Under this standard irrevocable liability occurs when there is an obligation to deliver the security. In this case that occurred when the office in Boston accepted the agreement and executed it in that office.
Defendants acknowledge this standard but argued that it does not resolve the question. Under the rule as applied by the Second Circuit, if the claims are “so predominantly foreign as to be impermissibly extraterritorial” then Section 10(b) has no application.
The Court, following the Ninth Circuit, rejected this rule as inconsistent with Morrison. The key to that decision, the Circuit Court concluded, is “not upon the place where the deception originated, but upon purchases and sales of securities in the United States.” In this matter that happened in Boston. Thus, Exchange Act Section 10(b) applies. The ruling of the District Court is affirmed.