District Court Applies Securities Fraud Provision to Foreign Transactions
January 8, 2025
Does § 10(b) of the Securities Exchange Act apply to securities on foreign exchanges? Generally, the answer is no. The Supreme Court held in Morrison v. National Australia Bank (2010) that § 10(b)—the Act’s principal antifraud provision—applies only to transactions on U.S. exchanges and to transactions in unlisted securities that occur in the United States.
But Congress amended the Securities Exchange Act shortly after Morrison to reinstate the conduct and effects tests that the Court rejected in Morrison for actions brought by the U.S. government. The problem is that Congress arguably amended the wrong section of the Act. Congress changed § 27, granting subject matter jurisdiction, rather than § 10(b) itself.
On December 21, 2024, in SEC v. Passos, Judge Gregory H. Woods (Southern District of New York) held that Congress’s amendment was sufficient to rebut the presumption against extraterritoriality and extend § 10(b) to securities on foreign exchanges in actions brought by the U.S. Securities Exchange Commission (SEC). Judge Woods’s decision is not the first to reach this conclusion. The Tenth Circuit did the same in SEC v. Scoville(2019). But Judge Woods’s decision is likely to prove influential, not just because he sits in the SDNY, but also because the opinion is thoughtful and thorough.
Making Stuff Up
The facts alleged in this case are startling. The defendant, Fernando Passos, worked for IRB Brasil Resseguros, a Brazilian reinsurance company whose shares trade on a Brazilian stock exchange. In 2020, a short seller of IRB stock published a letter questioning IRB’s financial results, citing among other things comments about the reinsurance industry by Warren Buffet, the CEO of Berkshire Hathaway.
Passos then arranged to plant and spread a false story that Berkshire Hathaway had recently made substantial purchases of IRB stock. In fact, Berkshire owned no IRB stock and had made no recent purchases. When Berkshire denied the story, IRB’s shares crashed. The SEC subsequently brought an action against Passos alleging violations of § 10(b), even though the shares were traded on a foreign exchange. Before the short seller’s letter, U.S. investors owned $1.6 billion in IRB stock, and the SEC alleged that certain U.S. investors purchased IRB stock while the false story was in circulation and had not yet been denied.
Morrison and Congress’s Amendment of the Securities Exchange Act
In Morrison, the Supreme Court applied the presumption against extraterritoriality to § 10(b), which prohibits the use of “any manipulative or deceptive device or contrivance” in connection with the purchase or sale of securities. The Second Circuit had developed a conduct test and an effects tests to determine when § 10(b) should apply extraterritorially. But the Supreme Court rejected these tests in favor of a “transactional test” limiting § 10(b) to transactions that occur on U.S. exchanges or otherwise occur in the United States. The Court also held that the geographic scope of § 10(b) was not a question of subject matter jurisdiction—as lower courts had generally held—but rather a merits question.
When Morrison was decided, Congress was in the final stages of considering the Dodd-Frank Act in response to the 2008 financial crisis. Shortly after Morrison, Congress added § 929P(b) to the Act, which supplemented Section 27’s provision on subject matter jurisdiction with the following language:
(b) Extraterritorial jurisdiction
The district courts of the United States and the United States courts of any Territory shall have jurisdiction of an action or proceeding brought or instituted by the Commission or the United States alleging a violation of the antifraud provisions of this chapter involving—
(1) 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
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.
This amendment aims to reinstate the conduct and effects tests for actions brought by the U.S. government. It is premised on the assumption that the extraterritoriality of the Securities Exchange Act is a question of subject matter jurisdiction, an assumption that Morrison rejected. It also extends beyond § 10(b) to other antifraud provision in the Exchange Act, such as § 14(e), which prohibits fraud in connection with a tender offer.
But if the extraterritorial reach of § 10(b) is a merits question, is amending the Act’s provisions on subject matter jurisdiction sufficient? Did Congress amend the wrong section of the Act and create jurisdiction over cases that its substantive provisions do not reach?
Judge Woods’s Decision
While Judge Woods’s acknowledged the Tenth Circuit’s decision in Scoville, he noted that neither the Second Circuit nor other district courts in the SDNY had directly addressed whether Congress’s amendment of § 27 was sufficient to expand the reach of § 10(b) in actions by the SEC.
He began with the text of § 10(b), which he noted “would not have to change to provide a cause of action against Defendant in this case.” The SEC alleged that Passos used an “instrumentality of interstate commerce or of the mails” to deceive investors with respect to IRB stock. The problem in Morrison was not that the language could not be read to apply extraterritorially but rather that it did not provide an “affirmative indication” of extraterritoriality to rebut the presumption.
Congress’s amendment of § 27, Judge Woods reasoned, “provides the ‘affirmative indication’ of extraterritorial application that did not exist when the Court issued Morrison.” Citing Morrison and RJR Nabisco, Inc. v. European Community (2016), the district court correctly noted that an affirmative indication of extraterritoriality need not be found in the text of the provision itself. It may instead come from “context.”
“It would have been pointless for Congress to define a ‘conduct’ test and an ‘effect’ test for jurisdiction over Section 10(b) enforcement actions if the scope of Section 10(b) never reached that conduct,” Judge Woods explained. “Reading Section 10(b) to apply to conduct that meets Section 27(b)’s ‘conduct’ or ‘effect’ tests ensures that Section 27(b)’s demarcation of extraterritorial jurisdiction over Section 10(b) enforcement actions by the SEC is not ‘superfluous, void, or insignificant.’”
The court then concluded that the SEC’s allegations satisfied the conduct test in § 27(b)(1) because the defendant was alleged to have exchanged dozens of text messages while he was in New York to spread the false story and forwarded a fake schedule of shareholders to support the story. Judge Woods rejected the argument that most of the defendant’s activities in furtherance of the scheme occurred in Brazil. “Section 27(b)(1) does not ask whether more of a defendant’s violative steps occurred in the United States than elsewhere,” he explained. “It asks only whether the steps the defendant took within the United States are ‘significant.’”
The district court did not find it necessary to decide whether the defendant’s alleged activities outside the United States had a “foreseeable substantial effect within the United States” for purposes of § 27(b)(2). But it did rely on effects in the United States to establish personal jurisdiction over the defendant, suggesting that this test could have been met as well.
Conclusion
SEC v. Passos seems like precisely the kind of case that Congress wanted to reach when it amended the Securities Exchange Act after Morrison. Although IRB’s shares are not listed on a U.S. exchange, U.S. investors had purchased $1.6 billion of those shares. The defendant knew this and contrived a scheme to deceive those investors and others, which he pursued while he was physically present in the United States. There is no doubt that the SEC should have the power to pursue this defendant.
However, the injured U.S. investors cannot sue the defendant or IRB directly for the money they lost because of this scheme. Those investors are still bound by Morrison, which precludes private actions under § 10(b) unless the transaction occurs in the United States. The Dodd-Frank Act called for the SEC to study whether the conduct and effects tests should be reinstated for private actions, too, but Congress has taken no further action. Perhaps it is time for Congress to revisit that question.