US Government restores the extra-territorial reach of the SEC to foreign companies

Key issues

On 24 June 2010, the Supreme Court of the United States held in Morrison v National Australia Bank (Morrison) that the anti-fraud provisions of the Securities and Exchange Act of 1934 (SEC Act), are only applicable to the purchase or sale of any security registered on a United States securities exchange or the purchase or sale of any other security in the United States.

The decision severely restricted the extra-territorial application of the SEC Act and was of wide-reaching significance for non-United States companies and, in particular, how they ought to structure the issue of securities so as to avoid potential SEC Act liability. A more detailed discussion of that decision can be found in our previous article ‘US Supreme Court restricts the extra-territorial reach of the SEC Act’.¹

The effect of that decision has now been curtailed by the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) which was enacted on 21 July 2010. The Dodd-Frank Act extends the extra-territorial reach of the Securities and Exchange Commission (SEC) and Department of Justice (DOJ) in relation to the enforcement actions brought by those bodies for cases of transnational fraud in breach of the anti-fraud provisions of United States federal securities laws. At present, the Dodd-Frank Act does not disturb the effect of Morrison in relation to actions brought by private investors in relation to cases of transnational fraud. However, the Dodd-Frank Act requires the SEC to conduct a study into whether or not private investors should also be permitted to bring such actions.

The Dodd-Frank Act

The Dodd-Frank Act is a wide-ranging piece of legislation dealing with many aspects of the provision of financial services. It was signed into law by President Barrack Obama on 21 July 2010.

Section 929P of the Dodd-Frank Act amends the anti-fraud provisions of United States federal securities laws (section 27 of the SEC Act, section 22 of the Securities Act of 1933 and section 214 of the Investment Advisers Act of 1940) to give the SEC and DOJ extra-territorial jurisdiction over actions involving:

• conduct within the United States that constitutes significant steps in the furtherance of the violation, even if the securities transaction occurs outside the United States² and involves only foreign investors, or 
• conduct occurring outside the United States that has a foreseeable substantial effect.

The amendments effectively reinstate the ‘conduct’ and ‘effects’ tests in relation to cases of transnational fraud which were rejected by the Supreme Court in Morrison. In this regard, the application of the new provisions will be the subject of much interest and scrutiny, given the Supreme Court’s characterisation of the interpretation of those tests over time by various United States courts as being unpredictable and inconsistent.

In addition, section 929Y of the Dodd-Frank Act requires the SEC to seek public comment and thereafter conduct a study to determine the extent to which private rights of action under the antifraud provisions of the SEC Act should also be permitted to be brought on the same grounds outlined above. The study will consider and analyse:

• the scope of such a private right of action, including whether it should extend to all private actors or whether it should be limited to extend just to institutional investors
• the implications such a private right of action would have on international comity
• the economic costs and benefits of extending a private right of action for transnational securities frauds, and 
• whether a narrower extraterritorial standard should be adopted.

The report is required to be submitted and recommendations made  to the relevant Senate and House Committees by not later than 21 January 2012 (18 months from the enactment of the Dodd-Frank Act).

What does this mean for you?

Companies should be aware that their ability to structure international securities issues so as to avoid liability for breaches of anti-fraud provisions of United States federal securities laws has been restricted in the context of SEC and DOJ enforcement actions.

Actions brought by the SEC and DOJ and decisions of United States courts pursuant to these new provisions should be closely monitored so that companies can obtain some guidance as to how the tests for extra-territorial application will be applied.

Structuring transactions to avoid potential claims from private investors is still possible. However, companies should monitor the outcome of the SEC’s study (and any potential new legislation) into whether or not private investors will be given the right to bring extraterritorial actions. Companies may also wish to consider making submissions to the SEC.

In addition, private investors may also seek to obtain redress through the Office of the Investor Advocate which has been established within the SEC by the Dodd-Frank Act. The role of the Advocate includes identifying problems that investors have with financial service providers and investment products.

This article was written by Leon Chung, Senior Associate, Sydney.

Endnotes

1. Freehills article, ‘US Supreme Court restricts the extra-territorial reach of the SEC Act’ 
2. Or even if the violation is committed by a foreign adviser in the case of the Investment Advisers Act.

More information

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