In Short
The Situation: The U.S. Court of Appeals for the Tenth Circuit recently addressed the issue of whether the antifraud provisions of the federal securities laws apply extraterritorially in enforcement actions commenced by the Securities and Exchange Commission ("SEC").
The Result: In SEC v. Scoville, the Tenth Circuit held that the Dodd-Frank amendments to the federal securities laws demonstrated that Congress intended for these laws to apply extraterritorially in enforcement actions under certain circumstances.
Looking Ahead: The Tenth Circuit's decision
sets the stage for different territoriality standards to be applied
in enforcement actions commenced by the SEC (or Department of
Justice) and private actions commenced by investors and other
market participants. These different standards could create more
uncertainty for market participants who were already struggling to
understand whether and under what circumstances securities
transactions with significant foreign components could subject them
to liability under the U.S. securities laws.
The Playing Field Pre-Scoville
In the landmark Morrison v. National Australian Bank Ltd. decision in June 2010, the U.S. Supreme Court concluded that since the text of Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") was silent on whether it should apply extraterritorially, it applied only to securities transactions within the territorial jurisdiction of the United States. In reaching this conclusion, the Court expressly rejected the "conduct-and-effects" test previously used by courts in the Second Circuit to determine the territorial reach of the Exchange Act (which the Court characterized as "unpredictable and inconsistent"), and adopted a new, "clear test" for identifying transactions subject to the Exchange Act. Under this new test, Section 10(b) was deemed to apply only to: (i) "transactions in securities listed on domestic exchanges"; and (ii) "domestic transactions in other securities."
Just one month after the Court issued its decision in Morrison, Congress enacted the Dodd-Frank Act, which amended (among other things) the jurisdictional provisions of the Securities Act of 1933 (the "Securities Act") and the Exchange Act. These amendments expressly provided that the federal district courts had jurisdiction over actions brought by the SEC or Department of Justice for violations of the securities laws involving either: (1) significant conduct in the U.S. in furtherance of the violation, "even if the securities transaction occurs outside the United States and involves only foreign investors"; or (2) "conduct occurring outside the United States that has a foreseeable substantial effect within the United States." This two-part test effectively mirrored the "conduct-and-effects" test the Supreme Court rejected in Morrison.
The Scoville Decision
In Scoville, the SEC alleged that the defendants, an internet traffic exchange and its sole member/manager, engaged in a worldwide Ponzi scheme involving the sale of "Adpacks," or "bundled internet advertising services that allowed a purchaser to share in some of [the exchange's] revenue". While the defendants ran their business out of an apartment in Utah, approximately 90% of the Adpacks at issue were allegedly sold to people living outside the U.S., including in Bangladesh, Venezuela, and Morocco. The SEC alleged that the Adpacks qualified as "securities" under the federal securities laws, and that the defendants' alleged scheme violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act. The U.S. District Court for the District of Utah rejected the defendants' argument that the sales of Adpacks to foreign customers were outside the reach of the federal securities laws, and granted the SEC's request to freeze the defendants' assets, appoint a receiver, and preliminarily enjoin the defendants from continuing to operate their business.
On January 24, 2019, the Tenth Circuit affirmed the district court's orders and agreed with the district court's conclusion that the defendants' marketing and sales of Adpacks to foreign customers were within the reach of the federal securities laws. The Tenth Circuit held that the Dodd-Frank amendments to the Securities Act and the Exchange Act evinced Congressional intent for these laws to apply extraterritorially in certain circumstances, stating that: "it is clear to us that Congress undoubtedly intended that the substantive antifraud provisions should apply extraterritorially when the statutory conduct-and-effects test is satisfied." The Tenth Circuit concluded that because the internet traffic exchange was created in the U.S., operated in the U.S., and had its servers in the U.S., the defendants' conduct in the U.S. was sufficient for the securities laws to apply, even if the victims of the scheme were located outside the U.S.
Impact Going Forward
The Scoville decision is the first appellate court decision to conclude that following Dodd-Frank, the antifraud provisions of the federal securities laws apply extraterritorially when the "conduct-and-effects" test is met in enforcement actions. The transactional test described by the Supreme Court in Morrison will continue to apply in private actions alleging violations of the securities laws, and as a result market participants could face different results in enforcement and private actions related to the same transactions. The Scoville decision therefore makes it even more difficult for market participants to predict whether transactions with foreign components could subject them to liability under the U.S. securities laws.
Three Key Takeaways
- The Tenth Circuit is the first appellate court to address the territorial reach of the antifraud provisions of the securities laws in enforcement actions post-Dodd-Frank, and it concluded that the antifraud provisions can be applied extraterritorially in such actions (subject to the limitations imposed by the "conduct-and-effects" test).
- Even though the "conduct-and-effects" test was heavily criticized pre-Morrison for its unpredictability, the Tenth Circuit offered no specific guidance on how it should be applied going forward in SEC actions. Until other courts provide guidance, there will be considerable uncertainty about what kinds of transactions satisfy the "conduct-and-effects" test.
- Applying the "conduct-and-effects" test in enforcement actions and the transactional test articulated in Morrison in private actions has the potential to result in inconsistent decisions related to the same underlying conduct.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
