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Stock fraud law: for U.S. only


Dismantling a legal edifice built up by lower courts over nearly a half-century, the Supreme Court on Thursday ruled that America’s main law against securities fraud does not apply to investment deals that occur outside of this country, even if they have some domestic impact or effect.  For the first time, the Court declared that the most-used U.S. stock fraud law cannot be used in American courts to challenge a “transnational” securities deal involving a company whose stock is not traded in the U.S., and when the trade does not occur inside the U.S.  With evident sarcasm, Justice Antonin Scalia’s opinion for the Court rapped Circuit Courts for having created, by judicial invention, the authority to decide such lawsuits when filed by private investors.  This, Scalia said, is “judicial-speculation-made-law.”

Section 10-b of the Securities Exchange Act of 1934, the law at issue, does not “focus…upon the place where the deception originated, but upon purchases and sales of securities in the United States,” the Court ruled in a case involving an Australian bank and Australian investors, whose complaint has a link to faulty financial information generated in Florida..  “Only transactions in securities listed on domestic exchanges, and domestic transactions in other securities” are covered by this provision, it stressed.

The Court was unanimous (although Justice Sonia Sotomayor did not take part) in ruling that this particular lawsuit could not go forward, but the Justices actually split 6-2 on the question of whether the securities fraud provision does reach, at least some of the time, beyond this country’s shores.  Justice John Paul Stevens, joined by Justice Ruth Bader Ginsburg, protested in a separate opinion that the new decision was part of “the Court’s continuing campaign” to “render toothless” the right of private investors to sue to enforce Section 10-b.  (The case did not deal with the U.S. Securities and Exchange Commission’s authority, but only with private investors’ lawsuits.)

The Court finally took on the issue, after years of declining to review it in a series of cases.  It did so in a case involving three Australian investors who had bought stock in their home country’s largest bank, National Australia Bank.  The bank’s stock is traded only on foreign markets, and not in the U.S.  Their lawsuit contended that a subsidiary of the bank in Jacksonville, Fla. — HomeSide Lending Inc. — had miscalculated interest rates on mortgages it was servicing, causing the parent bank to have to make millions of dollars in write-downs.  The investors contended that the HomeSide statements were false and misleading, thus affecting the value of their investment in the bank’s stock.   The investors took their case to the Supreme Court after having it dismissed in lower courts for having an insufficient link to the U.S.

Justice Scalia’s opinion was tartly critical of the Second Circuit Court, which had started in 1968 a trend that eventually spread to all of the other Circuit Courts, to develop an interpretation of Section 10-b that gave it — in at least some cases — a reach beyond the United States’ own territory.   The entire project was built on the premise that courts could determine what Congress would have intended, in allowing private investors’ fraud claims to go forward in U.S. courts based on transnational deals, if it had thought about the particular transaction.  The Court on Thursday, however, concluded that this entire effort was misguided, and that the controlling issue was a long-standing “presumption” that U.S. laws did not apply beyond this country unless Congress had expressly said they did.  There is no such indication in Section 10-b, the Court concluded.

The juridical project nullified by the new ruling had grown mainly out of the work of a highly respected Second Circuit Judge, Henry J. Friendly.  Justice Stevens, in his separate opinion, referred to the Second Circuit as the “Mother Court of securities law” and to Judge Friendly as the “master arborist” tending to “a judicial oak which has grown from little more than a legislative acorn.”  Justice Scalia countered with a footnote saying that the lower courts had not been tending to “the same mighty oak,” but, by their varying interpretations of how to apply the doctrine, “are in reality tending each its own botanically distinct tree.”

Focusing entirely on the presumption against overseas application of U.S. law, the Scalia opinion examined the text of Section 10-b, and found “nothing to suggest it applies abroad.”  The opinion flatly rejected the argument — supported in part by the U.S. Securities and Exchange Commission — that domestic effects of a transnational securities deal can sometimes come under Section 10-b.

Using a metaphor of his own, Scalia wrote that “the presumption against extraterritorial application would be a craven watchdog indeed if it retreated to its kennel whenever some domestic activity is involved in the case.”

The case is Morrison, et al., v. National Australia Bank, et al. (08-1191).  The lead name on the case, Robert Morrison, is that of an American who had sought to sue on behalf of a class of American investors, but his claim was dismissed on grounds not at issue in the appeal.  As Justice Scalia noted, his name remained in the case title without explanation.