The U.S. Court of Appeals for the First Circuit held yesterday that the U.S. securities laws apply to foreign brokers’ solicitations of securities purchases by foreign investors if the purchasers or sellers incurred irrevocable liability within the United States to pay for or deliver the securities. The decision in SEC v. Morrone follows the “irrevocable liability” test that the Second, Third, and Ninth Circuits previously adopted to determine whether the federal securities laws apply to transactions in securities not listed on a U.S. exchange. However, the First Circuit disagreed with other Second Circuit precedent holding that, even if a domestic transaction has occurred under the “irrevocable liability” standard, the transaction still might be too foreign for U.S. law to apply.
For several decades before the Supreme Court’s 2010 decision in Morrison v. National Australia Bank, courts had allowed securities plaintiffs to bring “extraterritorial” claims under the federal securities laws based on some version of the “conduct/effects” test. That test had examined whether significant wrongful conduct related to non-U.S. securities transactions had occurred in the United States or whether wrongful conduct outside the United States had had a substantial effect on U.S. markets or investors.
In 2010, the Supreme Court rejected the “conduct/effects” test and announced a new “transactional” test for determining the federal securities laws’ reach. Morrison 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.” One month later, Congress amended the securities laws through the Dodd-Frank Act and appeared to reinstate the “conduct/effects” test for the United States (and the SEC), but not for private litigants.
The Morrone Decision
Morrone involved a U.S. company that had solicited investments from U.S. and non-U.S. investors. To attract non-U.S. investors, the company and the individual defendants had worked with a “consulting” company that charged a 75% fee for any investor funds it raised. The U.S.-based defendants had prepared solicitation materials and a stock subscription agreement for the consultant to use with the non-U.S. investors. The SEC eventually filed a complaint against the defendants for securities fraud and other violations of the U.S. securities laws.
Defendants argued that the U.S. securities laws did not apply to their alleged conduct involving the non-U.S. investors. The District Court rejected the argument and granted partial summary judgment for the SEC. The First Circuit affirmed.
The First Circuit’s Decision
The First Circuit upheld the application of the U.S. securities laws under Morrison’s second prong, for domestic transactions in unlisted securities. The court followed the Second, Third, and Ninth Circuits in holding that a transaction is “domestic” under Morrison if “‘irrevocable liability’ occurs in the United States.” Quoting the Second Circuit, the First Circuit ruled that “parties to a transaction incur irrevocable liability if the purchaser incurred irrevocable liability within the United States to take and pay for a security or . . . the seller incurred irrevocable liability within the United States to deliver a security.”
The court concluded that defendants here had “incurred irrevocable liability within the United States to deliver a security.” The subscription agreements for the company’s stock said that the company had “‘no obligation’” under them until the company “‘execute[s] and deliver[s] to the Purchaser an executed copy’ of the agreement.” Defendants had executed the subscription agreements in Boston and had issued shares to the non-U.S. investors from Boston. The transactions thus were domestic under the “irrevocable liability” standard.
Defendants invoked the Second Circuit’s 2014 ruling in Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings and argued that, even if a “domestic transaction” under Morrison had occurred, U.S. law still should not apply if the claims “are so predominantly foreign as to be impermissibly extraterritorial.” The First Circuit rejected the Parkcentral standard as “inconsistent with Morrison” – a conclusion that the Ninth Circuit also had reached in Stoyas v. Toshiba Corp. According to the First Circuit: “The existence of a domestic transaction suffices to apply the federal securities laws under Morrison. No further inquiry is required.”
The First Circuit also held, however, that, even if it were to apply Parkcentral, it would still conclude that the claims here were not “so predominantly foreign as to be impermissibly exterritorial.” Nearly all the allegedly fraudulent conduct had occurred in the United States, and the company was a U.S.-based company not traded on a foreign exchange.
The Morrone case aligns the First Circuit with the Second, Third, and Ninth Circuits on the definition of a “domestic transaction” under Morrison’s second prong. The “irrevocable liability” test is now widely used in securities cases involving extraterritorial elements.
But the decision heightens the tension between the Second Circuit’s Parkcentral ruling and the First and Ninth Circuit positions on whether a domestic transaction alone suffices or whether something more is needed. While a sharp doctrinal difference appears to exist, however, the practical import of that difference is less clear. The First Circuit held that the claims here were not so “predominantly foreign as to be impermissibly extraterritorial,” and the Ninth Circuit had shifted consideration of some of those issues to Securities Exchange Act § 10(b)’s separate requirement that the alleged fraud have occurred “in connection with” the purchase or sale of securities.
The Morrone case also indirectly raises another potentially intriguing question for cases brought by the United States or the SEC. The SEC was not able to rely here on Congress’s 2010 reinstatement of the conduct/effects test for the Government because the underlying events had occurred before 2010. However, the First Circuit observed in a footnote that, “shortly after Morrison was decided, Congress amended the federal securities laws to ‘apply extraterritorially when the [newly-added] statutory conduct-and-effects test is satisfied,’” quoting the Tenth Circuit’s 2019 decision in SEC v. Scoville. The 2010 amendment provides that federal courts have “jurisdiction” over cases brought by the Government where the conduct/effects test is met. However, one month earlier, the Supreme Court had held in Morrison that the securities laws’ applicability to extraterritorial transactions is not a jurisdictional issue; it involves an element of the cause of action. Congress thus appears to have made a jurisprudential mistake in framing the Dodd-Frank amendment in jurisdictional terms.
Accordingly, the question arose whether Congress had actually succeeded in reinstating the conduct/effects test to determine the securities laws’ applicability for the Government or whether it had legislated a meaningless tautology, inasmuch as federal courts have always had “jurisdiction” over cases alleging violations of federal law. The Tenth Circuit held in Scoville that the amendment achieved what Congress presumably had sought to do: it allows the Government to proceed under the conduct/effects test, rather than under Morrison’s “transactional” test. By citing Scoville, the First Circuit might have implicitly agreed with that ruling, although the question had not been presented because the amendment clearly did not apply in Morrone.