A federal court in Utah recently held that the Securities and Exchange Commission may bring an enforcement action based on allegedly foreign securities transactions involving non-U.S. residents if sufficient conduct occurred in the United States.
The March 28, 2017 ruling in SEC v. Traffic Monsoon, LLC (D. Utah) appears to be the first decision squarely resolving whether the Dodd-Frank Act succeeded in allowing the Government to pursue such claims. The court recognized that the Act’s grant of “jurisdiction” to federal courts over enforcement actions relating to non-U.S. securities transactions had inartfully responded to the Supreme Court’s ruling in Morrison v. National Australia Bank, which had limited the substantive scope of the federal securities laws to U.S.-based transactions and had held that the extraterritorial extent of U.S. law is not a “jurisdictional” issue. But the Utah court ruled that, despite Congress’s mistake in framing Dodd-Frank’s provisions as “jurisdictional,” Congress had clearly intended to allow the SEC and the United States to sue based on conduct or effects within the United States, regardless of where the securities transactions occurred.
For several decades before the Supreme Court’s 2010 decision in Morrison v. National Australia Bank, courts throughout the country had allowed private plaintiffs and the Government to bring “extraterritorial” claims under the federal securities laws based on some version of the “conduct and effects” test. That test examined whether significant wrongful conduct related to the transaction had occurred in the United States or whether the wrongful conduct had had a substantial effect in the United States. Courts had also generally viewed the test as relating to subject-matter jurisdiction over extraterritorial securities claims.
In 2010, the Supreme Court threw out the “conduct and effects” test and announced a new “transactional” test for determining the federal securities laws’ reach. The Morrison decision held that the securities laws apply only to alleged misstatements or omissions made “in connection with the purchase or sale of [i] a security listed on an American stock exchange, and [ii] the purchase or sale of any other security in the United States.” The Court also made clear that the scope of the federal securities laws is not a “jurisdictional” issue at all; it concerns the substance of the securities statutes.
The Morrison decision was announced on June 24, 2010. On July 21, 2010 – less than one month later – President Obama signed the 850-page Dodd-Frank Act, several sections of which addressed the federal securities laws’ extraterritorial application. Section 929P(b) of the Act added language to the Securities Act and the Securities Exchange Act stating that the federal district courts “shall have jurisdiction of any action or proceeding brought or instituted by the [SEC] or the United States” alleging a securities-law violation involving:
- “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
- “conduct occurring outside the United States that has a foreseeable substantial effect within the United States” (emphasis added).
Thus, the Dodd-Frank Act appeared to be an effort to restore the “conduct and effects” test, rather than a transactional test, for governmental (but not private) securities actions. However, the Act was framed in terms of courts’ “jurisdiction” over those actions, even though Morrison had held four weeks earlier that the securities laws’ extraterritorial scope is not a jurisdictional issue. Dodd-Frank did not amend the substantive liability provisions of the Exchange Act or the Securities Act.
Several litigants have raised this issue since 2010, but no court ever decided whether the Dodd-Frank Act had succeeded in restoring the “conduct and effects” test for the SEC. Instead, those courts noted the potential problem, but ultimately held that the SEC’s allegations sufficed even under Morrison’s transactional test. The Utah court, however, took the bait and ruled.
The Traffic Monsoon Decision
Traffic Monsoon is a Utah-based company that allegedly makes most of its money selling advertising packages to “members.” Approximately 90% of those members reside outside the United States and presumably bought the ad packages while in their home countries. The SEC alleged that the sale of the packages constituted an illegal Ponzi scheme in violation of § 10(b) of the Exchange Act and § 17 of the Securities Act.
Defendants argued that, at least as to the non-U.S. transactions, the court could not enjoin the allegedly illegal activity because the non-U.S. customers had purchased the ad packs over the internet while located outside the United States. The SEC, in turn, asserted that, regardless of where the transactions had occurred, the Dodd-Frank amendments allowed the SEC to pursue its claims based on significant, allegedly wrongful conduct in the United States. These dueling contentions squarely raised the issue whether Dodd-Frank’s “jurisdictional” amendment had altered the substance of the Securities Act and the Exchange Act for SEC enforcement actions based on the “conduct and effects” test.
The court acknowledged that defendants were correct that “the plain language of Section 929P(b) did not explicitly overturn the core holding of Morrison,” in that § 929P(b) addressed only the court’s “jurisdiction” without amending the substantive scope of the securities statutes. However, the court noted that the Supreme Court had declared that the presumption against extraterritoriality could be rebutted by “all available evidence about the meaning of the statute – including the context provided by related statutes, history of amendments, underlying purpose, and legislative history.” After considering the available evidence, the court concluded that Congress had intended the Dodd-Frank amendments to allow the SEC and the United States to bring securities-law claims under the “conduct and effects” test even though the statute speaks in only “jurisdictional” terms.
The court observed that the initial versions of the Dodd-Frank amendments had been drafted before the Morrison decision, in response to the Second Circuit’s urging Congress to clarify federal courts’ “jurisdiction” to apply the securities laws to non-U.S. transactions. The conference report on Dodd-Frank was issued only five days after the Morrison decision. While
Congress is deemed to be familiar with Supreme Court precedents when it enacts legislation, “the more reasonable assumption is that Morrison was issued too late in the legislative process to reasonably permit Congress to react to it.” As the court colorfully noted: “To conform Section 929P(b) to the Morrison opinion at the last minute would be like requiring a steaming battleship to turn on a dime to retrieve a lifejacket that had fallen overboard. Thus, the court does not presume that Congress intended Section 929P(b) to be a nullity.”
The court therefore applied the “conduct” test and concluded that the SEC’s allegations satisfied that test: defendants had operated in the United States while allegedly defrauding foreign investors. But the court also held in the alternative that the SEC’s allegations satisfied Morrison’s transactional test, because defendants had sold their products over the internet and had incurred irrevocable liability in the United States to deliver the products to the buyers, wherever located.
The Traffic Monsoon decision appears to be the first case to squarely resolve the alleged drafting problem in Dodd-Frank. Prior decisions had avoided the issue by determining that the SEC’s allegations satisfied Morrison’s transactional test, regardless of whether the “conduct and effects” test might apply. The Traffic Monsoon court issued such an alternative holding as well, but it first bit the bullet and decided the Dodd-Frank issue.
The court certified its decision for an immediate interlocutory appeal to the Tenth Circuit under 28 U.S.C. § 1292(b). We might therefore have an appellate ruling on the issue by the end of the year, although the alternative holding based on Morrison’s transactional test could conceivably dissuade the Tenth Circuit from allowing the appeal.
The Traffic Monsoon ruling is probably not unexpected. Even though Congress failed to conform the Dodd-Frank amendment to Morrison’s decree about what is and is not “jurisdictional,” Congress’s intent seems to have been relatively clear. Courts are sometimes reluctant to play “gotcha” with Congress. But Traffic Monsoon does provide some welcome clarity on an issue that has been kicked around on at least a theoretical level since 2010.