The extra-territorial operation of US securities laws has been curbed by the United States Supreme Court in Morrison v National Australia Bank (08-1191), by requiring the purchase or sale of the security to be made in the United States, or involve a security listed on a domestic exchange.
The facts in Morrison v NAB
The plaintiffs are residents of Australia, who purchased National Australia Bank Limited's ("NAB") ordinary shares on an Australian exchange.
In February 1998, NAB acquired HomeSide Lending Inc., an American mortgage service provider. HomeSide calculated the present value of the fees it would generate from servicing mortgages in future years using a valuation method, booked that amount on its balance sheet as an asset called a Mortgage Servicing Right ("MSR"), and then amortised the value of the MSR over its expected life.
In 2001, NAB revealed that the interest assumptions and the valuation model used by HomeSide to calculate the MSR were incorrect and resulted in an overstatement in the value of its servicing rights. When NAB disclosed the error its share price fell.
Notwithstanding that they were Australian residents trading securities in an Australian company in Australia, the plaintiffs commenced their class action against NAB in the Southern District of New York.
They relied on section 10(b) of the Securities Exchange Act of 1934 which prohibits any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.
The trial judge, upheld on appeal, dismissed the claims on the basis that the court did not have jurisdiction. The Supreme Court of the United States agreed to hear the appeal.
Supreme Court upholds decision but substitutes new test
The Supreme Court relied on the longstanding principle of American law that legislation of Congress is meant to apply only within the territorial jurisdiction of the United States, unless a contrary intent appears. The Court found that section 10(b) is not extra-territorial.
The US Supreme Court therefore adopted a transactional test for the application of section 10(b): whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.
This replaced the previous tests for the application of section 10(b) that required either (1) an “effects test,” ie. “whether the wrongful conduct had a substantial effect in the United States or upon United States citizens,” or (2) a “conduct test,” “whether the wrongful conduct occurred in the United States.”
The Supreme Court’s application of the presumption against extra-territorial operation was bolstered by the amicus briefs from a number of other countries, including Australia, which led the Court to observe:
"The probability of incompatibility with the applicable laws of other countries is so obvious that if Congress intended such foreign application “it would have addressed the subject of conflicts with foreign laws and procedures.”
Like the United States, foreign countries regulate their domestic securities exchanges and securities transactions occurring within their territorial jurisdiction. And the regulation of other countries often differs from ours as to what constitutes fraud, what disclosures must be made, what damages are recoverable, what discovery is available in litigation, what individual actions may be joined in a single suit, what attorney’s fees are recoverable, and many other matters."
Will the US Congress act?
Although applying settled rules of US statutory construction the Court was clearly concerned with conflicts among national regulatory regimes and forum shopping:
"While there is no reason to believe that the United States has become the Barbary Coast for those perpetrating frauds on foreign securities markets, some fear that it has become the Shangri-La of class-action litigation for lawyers representing those allegedly cheated in foreign securities markets."
The lawyer for the investors opined that the ruling “severely limits investors’ remedies against securities fraud and it creates a risk that the U.S. will become a center for fraudulent activity,” and further stated that “We’re hopeful Congress in its current work on financial regulatory reform will overrule this decision.”
Similarly Justice Stevens, who concurred in the judgment, finding that the case “has Australia written all over it” dissented “from the Court’s continuing campaign to render the private cause of action under §10(b) toothless.”