In Morrison v. NAB the Supreme Court established the "transactional test," which turned on its head decades of lower court jurisprudence involving multi-national securities class action litigation. Rather than merely deciding narrowly on the facts in Morrison, the Court chose to adopt a black letter test that, at first glance, appears to bar all federal securities fraud suits in the US for securities traded on a foreign stock exchange. The implications for private plaintiffs as well as the SEC seemed far reaching as many securities class actions have historically involved an eclectic array of parties hailing from all corners of the globe.
However, in a timely display of democratic balance, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) on July 21, 2010. Title 9 of the Act is devoted to investor protections. It addresses, among other things, several key Morrison issues with respect to securities class actions. The event saw the realization of some expected changes with a few twists.
- SEC and DOJ Extraterritorial Reach - As expected the Act codifies the SEC and DOJ's power to enforce federal antifraud securities legislation with respect to conduct abroad. Federal courts will have jurisdiction to hear such actions where (1) "conduct within the United States...constitutes significant steps in furtherance of the violation," or (2) conduct occurring outside of the United States...has foreseeable substantial effect within the United States. This is a formulation similar to the Second Circuit's vaunted "conduct and effects" test that was applied prior to the Morrison decision. Thus, the SEC will have the power to pursue certain market participants under US federal law even if their conduct occurred outside of the US.
- Private Parties Extraterritorial Reach - Also as expected, the Act did not go so far as to codify extraterritorial application of federal securities fraud laws for private parties. Under Section 929Y of the Act, the SEC is charged with soliciting public comment and conducting a study on whether the federal antifraud laws should be extended to cover conduct outside the US. A report of the study with recommendations is to be submitted to Congress within 18 months after the date of enactment.
- SEC and DOJ Aiding and Abetting - As expected, the Act significantly expands the reach of the SEC's enforcement power against aiders and abettors of securities fraud and related claims. The Private Securities Litigation Reform Act of 1995 (PSLRA) gave the SEC the right to bring claims for aiding and abetting violations of the Secuities Exchange Act of 1934. But, the PSLRA required that the SEC show that the defendant(s) knew of the misconduct, which has been interpreted by several courts to mean actual knowledge. The new standard of proof under the Dodd Act requires only that the SEC establish a "reckless" state of mind. The Act also expanded the remedies available to the SEC when suing aiders and abettors. The Act gives the SEC the right to bring suit and seek civil penalties against aiders and abettors under the Securities Act of 1933 and the Investment Company Act of 1940. The Investment Advisors Act of 1940 was also amended to provide for civil penalties against aiders and abettors.
- Private Parties Aiding and Abetting - In an unexpected twist, the Act does not extend the right to sue aiders and abettors to private parties. This step, which was championed by Senator Arlen Spector and Representative Maxine Waters, would have overturned the Supreme Court's Stonebridge decision barring suit against aiders and abettors in securities fraud cases. However, similar to extraterritorial reach for private parties, the Act does provide for a Government Accountability Office (GAO) study on the propriety of aiding and abetting liability as a remedy for private litigants. The GAO has a year from enactment to report its findings to Congress.
What does the Dodd Act mean for the future of securities class actions? It has been noted in other commentary that the limitation on US securities fraud laws to domestic exchanges could mean as much as a 10% reduction in cases filed in the US annually coupled with a reduction in the size of many US class actions. In addition, collective action remedies in foreign countries continue to be complicated, and, in some cases, non-existent.
However, the above scenario could very likely be only a short-term result. There is a distinct possibility that, given the global recession and increased concern for consumer protection, the plaintiffs' bar will more vigorously and successfully pursue a uniform collective action regulation in the EU and similar remedies in other countries. This is not to mention that the Dodd Act dealt a significant blow to the Morrison decision. The SEC's power to pursue market fraud worldwide on behalf of aggrieved US investors is now undisputed. Also, pursuit of civil penalties against aiders and abettors under a much lighter burden of proof will mean potentially larger and more far reaching SEC enforcement actions on behalf of aggrieved investors.
Along with more authority given to the SEC, the Dodd Act has also given the SEC more funding. It has preliminarily authorized SEC funding that would effectively double its budget through 2015 and also gave it discretion to tap into a new $100 million reserve fund. The combination of funding and remedial ammunition could mean an invigorated SEC and a statistically significant spike in future SEC disgorgement actions. According to SEC Chairwoman Mary Schapiro, the SEC is revamping and stepping up its focus on enforcement. This seems to be the case as evidenced by the recent $550 million SEC settlement with Goldman Sachs. It is, therefore, quite possible that aggrieved US investors with claims against foreign defendants may have been left in the dark by Morrison but will nonetheless have a shoulder to cry on at the SEC.
Whether private parties will again be able to sue under federal law in US courts for conduct in connection with foreign traded securities, or whether they will be able to one day target aiders and abettors is still very much in doubt. The regulatory and legislative process for deciding this issue will take years. Meanwhile, the Supreme Court's decisions in Morrison and Stonebridge still stand. However, while the ultimate outcome is still very difficult to ascertain, the SEC may have revealed its hand somewhat in its Morrison amicus brief, which endorsed a rule of extraterritorial application that provides a private right of action in cases where the US conduct is both "significant" and "material." Will this or some other standard for extraterritorial application come to fruition? Only time will tell.