In Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court rejected extraterritorial application of federal securities laws. The Court held that the federal securities laws reach only (1) transactions in securities listed on domestic exchanges and (2) domestic transactions in other securities. Since the decision in Morrison was announced, several courts have considered the issue of what constitutes a “domestic transaction” for the purposes of federal securities laws under the second prong of Morrison.
The recent decision of the First Circuit in SEC v. Marrone, 997 F.3d 52 (1st Cir. 2021), adds to a circuit split on what constitutes a “domestic transaction” in the context of certain extraterritorial conduct. In Marrone, the First Circuit joined the Ninth Circuit in rejecting the Second Circuit’s approach to applying securities laws to extraterritorial conduct, and foregoing an analysis of the nature of the transaction and limiting the inquiry to the location where irrevocable liability occurred.
The Marrone case involved a company, Bio Defense Corporation (“Bio Defense”), which developed a machine to decontaminate letters potentially contaminated with biological pathogens. In 2008, a consultant hired by Bio Defense introduced the company to a consulting firm, Agile Consulting (“Agile”). Agile ran call centers targeting investors in Europe. The consultant, who had been previously convicted of conspiracy to commit securities fraud in an unrelated case, told senior officers of Bio Defense that Agile could help them raise money from foreign investors. The consultant told Bio Defense that this would be an expensive process and that Agile would charge a 75% fee for any investor funds it raised. Bio Defense entered into a contract with Agile in August 2008.
Pursuant to the agreement, Agile would solicit European investors and when it found interested investors, it would send their contact information the consultant who would pass the information on to senior Bio Defense officers. The Bio Defense officers would then finalize investor subscription agreements and issue stock certificates. Bio Defense raised approximately $3.3 million and paid Agile a fee of approximately $2.5 million for its work.
In 2012, the SEC filed suit against Bio Defense and its senior officers in the District of Massachusetts. The suit alleged several violations of federal securities law, including, among other things, securities fraud under 17(a) of the Securities Act of 1933 and violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. On September 6, 2019, the district court granted summary judgment to the SEC on several of its claims. The district court rejected claims by the defendants that federal securities laws did not apply to their solicitation of foreign investors and held that the transactions at issue were “domestic” pursuant to the Supreme Court’s decision in Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010). The defendants appealed to the First Circuit.
The First Circuit affirmed the decision of the district court applying federal securities law to the conduct of the defendants. The Court held that a transaction is “domestic” for the purposes of federal securities law if “irrevocable liability” occurs within the United States. The Court explained that because the subscription agreements were executed in the United States, and because the shares were issued in the United States, irrevocable liability to deliver the securities at issue took place in the United States.
The defendants had argued that even if a transaction were domestic because of the location of irrevocable liability, this alone is not enough to support a domestic claim under Morrison. In support of this position, the defendants urged the Court to adopt the Second Circuit’s reasoning in Parkcentral Global Hub Ltd. v. Porsche Automobile Holdings SE, 763 F.3d 198 (2d Cir. 2014). In Parkcentral, the Second Circuit held that securities laws do not apply to claims “so predominantly foreign as to be impermissibly extraterritorial,” even if the transactions meet the irrevocable liability test. The First Circuit rejected this approach, finding Parkcentral to be inconsistent with Morrison. The Court held that the mere existence of a “domestic” transaction is sufficient to apply federal securities laws, with no further inquiry necessary.
The First Circuit’s approach is the same taken by the Ninth Circuit, further widening the circuit split on the application of federal securities laws to extraterritorial conduct. Until the split is resolved, the reach of federal securities laws remains uncertain.
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About Dylan B. Weeks
Dylan B. Weeks is an Associate in Faruqi & Faruqi, LLP's New York office. His practice is focused on securities litigation.
Dylan B. Weeks
Associate at Faruqi & Faruqi, LLP
New York office
Tel: (212) 983-9330
Fax: (212) 983-9331