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US Supreme Court Limits Extraterritorial Reach of US Securities Law: Morrison v. National Australia Bank

Out of the US Supreme Court comes a positive development for Canadian issuers of securities who have business operations in the United States: the US Supreme Court held, on June 24, 2010, that the principal statutory provisions used by security-holders to bring class actions in the US — s.10(b) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 (which is promulgated under s. 10(b)) — have no application to trades in securities that are not traded on a US exchange and that do not take place in the US.

In Morrison v. National Australia Bank (08-1191), three Australian investors held ordinary shares in the National Australia Bank that were not traded on any exchange in the US. They attempted, however, to bring fraud claims in the US against the Bank under s. 10(b) and Rule 10b-5 because, they alleged, a Florida subsidiary of the Bank was the source of the Bank’s fraud on the market (in that it had allegedly miscalculated the interest rates on the mortgages it services and provided fraudulent financial information to the Bank, leading to a write-down of millions of dollars by the Bank). The investors alleged that their shares fell when the fraud was revealed.

The court ruled that the Australian investors’ case could not proceed. Justice Antonin Scalia, in the court’s majority opinion, held that because s. 10(b) and Rule 10b-5 contain no indication as to whether they are intended to apply extraterritorially, they must be interpreted as applying only within the confines of the US. Justice Scalia further opined that s. 10(b) and Rule 10b-5 focus on the purchase and sale of securities in the US, not on the place where the alleged fraud arose.

The court’s reasoning that these provisions cannot be relied upon to start a US case even if there were allegedly significant fraudulent conduct in the US, or if there were some effect on US markets or investors, strongly criticized a significant body of lower court decisions that employed this "conduct and effects" test. In other words, Morrison stands for the proposition that the provisions cover only transactions in securities listed on US exchanges and transactions in securities that are not listed on a US exchange, but take place in the US.

Accordingly, the court’s decision bars so-called "foreign-cubed" claims; that is, claims brought in the US by foreign investors who purchased, on foreign exchanges, securities of a foreign issuer. The court’s decision also goes further: it appears to bar claims in the US by resident investors who claim in respect of securities not listed on a US exchange and who cannot prove that the transaction occurred in the US. Future US decisions will certainly have to grapple with the issue of when a transaction occurs in the US such that it is under the scope of s. 10(b) and Rule 10b-5.

Morrison has a number of positive implications for Canadian and other foreign issuers of securities who have operations in the US, but do not trade on US exchanges or transact in securities in the US. Claims brought by investors are more likely to be brought in the jurisdiction where their securities are transacted or traded on an exchange; for Canadian issuers of securities, this will likely be Canada.

In addition, the court’s ruling may, indirectly, limit the scope of the SEC’s power to extraterritorially investigate and bring proceedings against foreign issuers of securities in situations where there is significant fraudulent conduct in the US. However, the SEC is currently lobbying for financial regulation reform that would authorize it to have this power.