The Supreme Court’s decision in Morrison v. National Australia Bank, Ltd., 130 S. Ct. 2869 (2010) dramatically changed the reach of Exchange Act Section 10(b), the antifraud weapon of choice for the SEC and private plaintiffs. The decision contracted the reach of the Section to the shores of the United States, holding that the purchase and sale of the security had to be either on an exchange or within the United States. The Court’s holding scraped years of Second Circuit jurisprudence and decisions by other courts which followed its lead that gave the Section extraterritorial effect based on two pronged conduct and effects test.

The significance of Morrison is underscored by the fact that just weeks after the Supreme Court handed down its decision, Congress tried for a legislative fix in Dodd-Frank. It added provisions to the Act which essentially incorporated the Second Circuit jurisprudence into the jurisdictional provisions for fraud actions brought by the SEC and the DOJ. At the same time Congress ordered the SEC to prepare a study regarding the impact of the High Court’s decision on private actions. Whether the legislative fix for the SEC and DOJ is effective remains an open question since Congress wrote it in terms of jurisdiction despite the fact that Morrision makes it clear that the question is not judicial power but the reach of the statute.

Now the staff has prepared its study which the Commission authorized be sent to Congress. Commissioner Aguilar however dissented arguing that the study is inadequate.

The staff’s study dutifully recounts the Supreme Court’s decision in Morrison. It also reviews the prior jurisprudence developed by the Second Circuit and the public comments solicited as the study was prepared. Included in that discussion is a review of the international implications of the extraterritorial reach of Section 10(b) and from the Morrison opinion, certain amicus briefs in that case and the comments.

The staff report does not make any recommendations. Rather, it contains two “options for consideration,” one of which has four variations:

Option 1: Conduct and effects test. The Congress can, according to the study, consider the enactment of the “conduct and effects” test for private actions in a fashion which is similar to the current Dodd-Frank provisions for the SEC and the DOJ. This would effectively codify the prior Second Circuit jurisprudence, a legislative overruling of Morrison for Section 10(b) but not for other matters (Morrison is based on statutory construction principles and has been applied to other statutes such as RICO). A variation of this approach would be to require that the plaintiff’s injury result directly from conduct in the U.S. the study notes. This is the approach argued by the Solicitor General and the Commission in Morrison. The Commission continues to support this standard the staff notes.

Option II: Alternate tests. The Report also offers four alternative options each of which essentially adopts a variation of arguments offered by plaintiffs in various cases in an effort to circumvent Morrison all of which have been rejected by the courts:

1) Permit plaintiffs to pursue a claim for the purchase and sale of a security of the same class of securities regardless of where the transaction took place.

2) Permit private actions against securities intermediaries such as brokers who are involved with the purchase or sale of a security overseas.

3) Provide a cause of action for investors who were fraudulently induced in the U.S. to enter into the transaction regardless of where it took place.

4) Permit suit when either party made the offer to sell or purchase, or accepted the offer to sell or purchase, while in the U.S for an off exchange transaction. .

Commissioner Aguilar dissented from the transmission of the study to Congress. He stated his “strong disappointment that the Study fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result” from the Court’s decision in Morrison. In support of his position the Commissioner details four key points:

  • The Study fails to adequately explain that private rights of action are a “vital complement” to Commission enforcement actions;
  • It overstates the international comity concerns associated with restoring a private right of action;
  • It fails to communicate the harm to investors or convey a sense of urgency; and
  • It provides as an option that Congress take no action.

In view of the current gridlock in Congress it is safe bet that the Commissioner’s last point is very likely the outcome here.

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