An oddball of a case by the Securities and Exchange Commission has just brought to a boil long-simmering tension between a provision in the Dodd-Frank financial reform law and the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank. And as Cleary Gottlieb Steen & Hamilton pointed out in a client alert on Monday, U.S. issuers of foreign-traded securities now have reason to worry about being sued or prosecuted by the U.S. government.
As you know, the Supreme Court’s Morrison decision held that unless U.S. laws specifically say they apply abroad, they should be presumed not to. The ruling, which came in the context of a securities fraud class action against an Australian bank, erased 40-year-old precedent from the 2nd U.S. Circuit Court of Appeals that allowed U.S. securities laws to be enforced against defendants whose supposed misconduct took place or had an effect in this country. Morrison’s ripples have spread far and wide, in both civil and criminal litigation, but its most profound impact has been in securities cases. It virtually knocked out big private securities fraud litigation against foreign issuers.
Less than a month after the Supreme Court issued its Morrison opinion, President Obama signed Dodd-Frank into law. One provision in the vast and sprawling collection of reforms extended the jurisdiction of U.S. courts to hear SEC or Justice Department cases involving foreign-traded securities as long as the defendant’s alleged misconduct took place or had a substantial effect in the U.S.
Essentially, as U.S. District Judge Jill Parrish of Salt Lake City explained last week in a precedent–setting opinion in SEC v. Traffic Monsoon, Dodd-Frank put into law the longstanding “conduct and effects” test a month after the Supreme Court abolished it in the Morrison decision.
But according to Judge Parrish, Congress wasn’t reacting directly to the Supreme Court’s ruling. By the time the court issued the Morrison decision, she said, lawmakers had been drafting Dodd-Frank for months. On the day Morrison came down, Congress was already deep into its final legislative conference on the law. That history, the judge wrote, shows the Dodd-Frank provision wasn’t written to undo Morrision. “To conform (the provision) to the Morrison opinion at the last minute would be like requiring a steaming battleship to turn on a dime to retrieve a lifejacket that fell overboard,” Judge Parrish wrote.
In the seven years since Dodd-Frank and Morrison debuted, there has been much judicial head-scratching about their interaction, as Judge Parrish’s opinion and the Cleary client alert point out. The Dodd-Frank clause, remember, grants jurisdiction to U.S. courts to hear SEC and DOJ securities cases. Morrison, however, didn’t restrict securities litigation against foreign issuers on the basis of jurisdiction. Morrison said U.S. securities laws don’t extend to foreign-traded securities. So the Dodd-Frank provision doesn’t specifically fix the extraterritoriality problem Morrison identified.
At least three federal trial courts have suggested Dodd-Frank overrides Morrison in cases brought by the SEC or Justice Department, according to Judge Parrish, but none before her opinion, no judge had actually decided the question.
The case before Judge Parrish was not a typical securities enforcement action. The SEC sued Traffic Monsoon, a Utah-based web advertising firm that actually made its money by selling an interest in the revenue it derived from “AdPacks” promising clicks and visits from banner ads. The SEC claimed Traffic Monsoon’s AdPacks program was actually a Ponzi scheme and sought to shut it down. The company’s lawyers at The Washburn Law Group and Smith Correll moved to dismiss the case, arguing (among other things) that because 90 percent of AdPack investors are based overseas, Morrison bars the SEC’s case.
Judge Parrish held that under Dodd-Frank, the appropriate question is whether the SEC’s allegations meet the pre-Morrison conduct and effects test. The Supreme Court restricted the reach of federal securities laws in Morrison because the laws themselves did not say they extended overseas. Dodd-Frank addressed that omission by codifying the conduct and effects test for cases brought by the SEC and Justice Department. And the SEC’s case against Traffic Monsoon met the test because it alleged the AdPack program was devised and executed in Utah.
The judge acknowledged that her analysis of Dodd-Frank and Morrison is debatable and certified her opinion for an interlocutory appeal. But in the meantime, Cleary wrote in its client alert, “This decision raises the possibility that foreign companies with no securities listed or sold in the United States may face a greater threat of federal securities liability from the SEC and U.S. Department of Justice.”
I left a phone message for Traffic Monsoon lawyer Loren Washburn but didn’t hear back.