Corporate Governance

Morrison, Tourre, and the Misguided Interpretation of Rule 10b-5 (SEC v. Tourre, Redux) (Part 6)

By J Robert Brown Jr.

We are discussing Morrison v. National Australia Bank, 130 S. Ct. 2869 (June 24, 2010), the Supreme Court case that held Rule 10b-5 does not have extraterritorial effect and the misreading of the decision by the lower courts.

The analysis in this series of posts started with the SEC's case against Fabrice Tourre.  He has moved to dismiss, relying on Morrison.  He is represented by Allen & Overy and, from the quality of the brief, has very good counsel.  In addition to strong arguments, the attorneys drafting the memorandum of law have written in a powerful but understated manner.  There is none of the bull-in-the-china-shop bluster that so often passes for good lawyering. 

The securities involved (the synthetic CDOs, Abacus 2007-ACI) are not listed on a US exchange.  Under Morrison, therefore, the only issue under Section 10(b) is whether the sale of the securities occurred in the US.  The SEC has alleged fraud in connection with two transactions involving a swap with ABN and the sale of notes to IKB, a German bank. 

IKB, according to the brief, bought the securities in London through a Regulation S transaction.  Regulation S explicitly applies to offers and sales 'outside the United States.'  Preliminary Note, Regulation S.  The swap with ABN occurred, according to Tourre, between ABN and Goldman Sachs International in a swap governed by English law.  

The Commission's response?  Also a well done piece but stuck with both the Supreme Court's reasoning in Morrison and the narrowing permutations of the lower courts.  The Commission asserts that a sale occurred in the US.  The brief includes a host of facts indicating activity in New York in connection with the securities at issue.  Mostly, though, the Commission asserts that jurisdiction applied because most of the 'selling process' took place in the US. 

Selling process does not look to be enough to acquire jurisdiction.  Morrison suggests that, under Section 10(b), the purchase or sale must itself be domestic.  This is not a foregone conclusion.  The issue is whether the sale involved a "domestic transaction" and a court has some flexibility to apply a totality of the circumstances approach in assessing the location of the transaction.  Nonetheless, that is not the approach the courts in the Southern District have been taking.  Moreover, the approach would require a facts and circumstances analysis for each transaction.

The Commission, however, brought the action against Tourre not only under Section 10(b) but also under Section 17(a) of the Securities Act.  Although courts have already concluded that the analysis in Morrison also applies to the Securities Act, the approach still needs to take into account the differences in language between Section 10(b) and 17(a).  While Section 10(b) applies to a purchase or sale, Section 17(a) extends the antifraud protections to offers and sales.  See Section 17(a), 15 USC 77q(a) (Section makes it 'unlawful for any person in the offer or sale of any securities').   Section 17 may not have any extraterritorial application but to establish US jurisdiction, plaintiffs presumably need only to show that an offer was made in the United States. 

The facts appear to support this argument.  The Commission includes a laundry list of activities that occurred in the US with respect to the sales, including the development and distribution of the fraudulent materials and the requirement that the closing take place in New York.  The complaint also notes that Tourre spoke to representatives from IKB 'to solicit interest' while in New York.  The brief and complaint list other alleged facts that involve interactions originating in New York between Tourre and IKB.  

The facts suggest that an offer may have occurred in the United States.  Moreover, the approach does not really broaden the reach of the antifraud provisions.  Private parties do not have an implied right of action under Section 17.  As a result, easing the jurisdictional requirements under Section 17 will only benefit the Commission.  

For primary materials on SEC v. Tourre, go to the DU Corporate Governance web site.  For primary materials in Morrison v. NAB, including the many amicus briefs filed in the case, go to the DU Corporate Governance web site.?

Full post as published by The Race to the Bottom on February 24, 2011 (boomark / email).