In United States v. Vilar, the Second Circuit Court of Appeals has offered another data point in the federal courts’ ongoing efforts to define the extraterritorial reach of the federal securities laws.
Although we expect regulators to argue that Vilar has limited application, the Second Circuit has, in fact, curtailed efforts to extend criminal liability to the extraterritorial purchase or sale of securities.
In Vilar, decided on August 30, the Second Circuit applied the “presumption against extraterritoriality” to claims of criminal liability under Section 10(b) of the Securities Exchange Act. In doing so, the Second Circuit expressly extended the Supreme Court’s 2010 decision in Morrison v. National Australia Bank Ltd. – a civil case in which the Court barred federal fraud suits by foreign investors over foreign-traded securities – to criminal actions brought by the Department of Justice.
Rejecting the government’s argument that Morrison only applies to civil actions, the Second Circuit concluded that criminal and civil defendants alike can only be found liable under Section 10(b) if the fraud occurred in connection with “a security listed on a U.S. exchange” or with “a security purchased or sold in the United States.”
Because none of the securities at issue in Vilar were listed on an American exchange, the Second Circuit followed Morrison and questioned whether the securities transactions constituted a domestic purchase or sale of securities. The Second Circuit held that a securities transaction is considered domestic “when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed in the United States.” (See the decision here). The Second Circuit concluded that, because certain alleged victims entered into and renewed agreements in Puerto Rico and New York, a jury would have found that the defendants engaged in fraud in connection with a domestic purchase or sale of securities and upheld the defendants’ convictions. By focusing on the nature of the securities transaction, the Second Circuit’s analysis in Vilar materially limits the conduct that is susceptible to criminal liability.
Questions remain re Morrison, Dodd-Frank
An open question remains, however, on the relationship of Morrison and its progeny, now including Vilar, and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Enacted after the Supreme Court’s decision in Morrison, certain provisions of Dodd-Frank amend the Exchange Act (and other securities laws) to expressly acknowledge the federal courts’ extraterritorial reach when enforcing the federal securities laws. The Exchange Act now provides that the courts have jurisdiction over actions by the SEC or DOJ involving “(1) conduct within the United States that constitutes significant steps 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.” 15 U.S.C. § 78aa(b).
The government did not invoke this provision of Dodd-Frank in Vilar – presumably because there was no plausible argument for its retroactive application. Going forward, while we can expect the government to argue that Dodd-Frank reestablishes the extraterritorial reach that Morrison and Vilar have curtailed, the chances of success appear slim because Dodd-Frank does nothing to actually expand the geographic reach of the substantive provisions of the Exchange Act. Rather, Dodd-Frank’s extraterritorial jurisdiction provision exclusively focuses on the federal courts’ jurisdiction.
A coming test case?
SEC v. Cañas Maillard, a civil enforcement action filed in the Southern District of New York in July, may present a test case for the government to attempt to assert its extraterritorial muscle in reliance on Dodd-Frank.1 In Cañas Maillard, the SEC has accused two Spanish citizens – one a high-ranking official at a Spanish bank, the other a close friend of the bank official – of committing insider trading in the securities of a Canadian company listed on the NYSE.
The SEC alleges that the bank official learned that a prospective buyer retained his bank to help underwrite the buyer’s confidential proposed acquisition of the Canadian target company. After learning that his bank had approved financing for the transaction, the bank official purchased the equivalent of 30,000 shares of the target company’s stock through a derivative product (which the SEC describes as “highly-leveraged securities”) available in Europe known as contracts-for-difference (CFDs). The bank official also informed his friend about the acquisition and advised him to trade, resulting in the friend’s purchase of 1,393 NYSE-traded shares of the target company.
The predicate for the SEC’s assertion of jurisdiction is the target company’s NYSE listing and the fact that some of the trades at issue occurred on the NYSE. Although the CFD trades did not occur in the United States, the SEC alleges that the CFDs were purchased through the Luxembourg-based affiliate of an American bank and that the bank purchased an equivalent amount of the underlying NYSE-traded shares to hedge its risk on the CFDs. While the SEC therefore appears primed to assert that the federal securities laws reach the CFD trades, following the analysis that the Second Circuit applied in Vilar, the CFD trades, which did not obligate the purchaser with regard to a US security, should be deemed foreign securities traded on a foreign exchange. Under Morrison and its progeny, the SEC should not be permitted to base liability on those foreign securities, and the bank official’s liability should be limited to tipping material non-public information to his friend.
As of the date of this alert, the defendants in Cañas Maillard have not responded to the SEC’s allegations, but DLA Piper will continue to monitor the case for further developments.