Morrison and the Effects Test

Morrison and the Effects Test

[William S. Dodge is a Professor of Law at the University of California, Hastings College of the Law. One of his articles on extraterritoriality was cited in Justice Stevens’s concurring opinion.]

There is no doubt that Morrison v. National Australia Bank is a landmark opinion, not just because the Supreme Court addresses here, for the first time, the extraterritorial reach of U.S. securities law, but also for what the opinion tells us more generally about the presumption against extraterritoriality.

As Margaret Sachs has already recounted, the Courts of Appeals, under the Second Circuit’s leadership, had established two tests for applying § 10(b) of the Securities Exchange Act to cases with foreign elements. Under the effects test, § 10(b) applied to foreign misrepresentations causing substantial effects in the United States. Such effects could be shown if the shares were traded on an American exchange or if fraudulent materials were sent to investors in the United States. Under the conduct test, § 10(b) applied to substantial misrepresentations in the United States that caused losses abroad. (For a summary of the law as it used to be, see Vagts, Dodge & Koh, Transnational Business Problems 454-57 (4th ed. 2008).)

In Morrison, Justice Scalia, writing for the Court, held that the presumption against extraterritoriality applies to the Securities Exchange Act. One might have guessed this would lead the Court to reject the effects test and limit § 10(b) to fraudulent conduct in the United States. But in fact the Court did the reverse, eliminating the conduct test and endorsing a narrower version of the Second Circuit’s effects test. Section 10(b), the Court held, can apply to fraudulent conduct abroad but only if the shares in question are listed on an American exchange or otherwise sold in the United States. How can this be so?

In an article published more than a decade ago, I noted that there are at least three ways to understand the presumption against extraterritoriality: (1) that acts of Congress should presumptively apply only to conduct in the United States regardless of whether the conduct causes effects in the United States (Justice Holmes’s view in American Banana); (2) that acts of Congress should presumptively apply only to conduct that causes effects in the United States regardless of where the conduct occurs (Judge Bork’s view in Zoelsch v. Arthur Anderson & Co.); and (3) that acts of Congress should presumptively apply to conduct occurring within or having effects within the United States (Judge Mikva’s view in Environmental Defense Fund v. Massey). Because I believe the only proper basis for the presumption today is the notion that Congress is primarily concerned with domestic conditions, I argued that Judge Bork’s view—that acts of Congress should presumptively apply only to conduct that causes effects in the United States—was the correct one.

A majority of the Supreme Court now seems to agree. The basis for the presumption, Justice Scalia writes in Morrison, is “the perception that Congress ordinarily legislates with respect to domestic, not foreign matters.” Slip Op. 5-6. “[T]he focus of the Exchange Act,” he continues, “is not upon the place where the deception originated, but upon purchases and sales of securities in the United States.” Slip Op. 17. In other words, the location of the fraudulent conduct is irrelevant; what matters is whether the conduct affects transactions within the United States. Moreover, Judge Bork’s opinion in Zoelsch questioning the conduct test but endorsing the effects test is virtually the only lower court opinion for which Justice Scalia has a kind word in Morrison. Slip Op. 10-11.

I agree with and applaud this understanding of the presumption against extraterritoriality. (Ironically, my article was cited not by Scalia’s majority opinion but by Justice Stevens’s concurrence.) But Morrison sits uncomfortably alongside other opinions written by Justice Scalia and Justice Thomas (whom Scalia routinely joins on such questions), which have focused formalistically on the location of the conduct. In Pasquantino, to take the most obvious example, Justice Thomas (writing for a majority that included Scalia) rejected the argument by Justices Ginsburg and Breyer in dissent that the presumption against extraterritoriality barred application of the federal wire fraud statute to a scheme hatched in the United States to defraud Canada of tax revenue. “This domestic element of petitioners’ conduct is what the Government is punishing in this prosecution, no less than when it prosecutes a scheme to defraud a foreign individual or corporation,” wrote Thomas. Morrison distinguishes Pasquantino on the ground that the wire fraud statute prohibits any fraud while § 10(b) prohibits only fraud “in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered.” Slip Op. 23. But if the text of § 10(b) limits its reach, resort to the presumption should have been unnecessary in Morrison. And if resort to the presumption was relevant in Morrison to determine what fraud Congress had in mind with respect to § 10(b), it should have been equally relevant in Pasquantino to determine what fraud Congress had in mind with respect to 18 U.S.C. § 1343.

I would like to say that Morrison represents convergence on the principle that when courts construe regulatory statutes in an international context it is the effects that matter, not the conduct. Justices Breyer and Ginsburg have emphasized in cases like Small v. United States the “commonsense notion that Congress generally legislates with domestic conditions in mind.” And Justice Stevens adopted an effects view of the presumption as far back as his 1992 concurrence in Defenders of Wildlife v. Lujan. But in Morrison, Stevens and Ginsburg would have preserved the Second Circuit’s conduct test and so concurred only in the judgment, while Breyer joined the majority only to the extent it is consistent with his own inscrutable one page concurrence. So if Justice Scalia’s approach to the presumption in Morrison is inconsistent with his earlier views, at least he is in good company.

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Thank you to Opinio Juris for hosting this very interesting discussion concerning Morrison. I no longer practice in this field so I may well be missing something.  But, as I understand it, in the face of congressional silence, the presumption against extraterritoriality should be applied in interpreting a statute.  What I find strange about the majority opinion, however, is that it largely ignored the various regulations adopted by the SEC that concern offshore transactions and alike. In particular, what to make of Regulation S that exempts certain issuers from registration that are engaged in offshore sales of securities?  Regulation S is seen as a safe harbor/carve out to what was generally considered the wide jurisdictional reach of US securities laws. Regulation S’s preamble specifically states that it does not apply to the anti-fraud provisions of the securities law.  I read this to mean that one can commit securities fraud even if the securities at issue need not be registered under the 33 Act, which is consistent with Second Circuit case law. The upshot of Morrison seems to be that all purchases and sales under Regulation S are no longer subject to the anti-fraud provisions.  In other words, Morrison seems to compel… Read more »

Tobias Thienel

There is another understanding of the presumption, or more particularly of the underlying reasons. This understanding has recently gained prevalence in English law; I mention it not because I presuppose that U.S. law is to the same effect, but because the English view is intimately connected with international law, and thus with the main theme of this blog. Of course, English law has long known a presumption against extraterritoriality, expressed – and not fully expressed – much like the American presumption. In short, Acts of Parliament are presumed not to have extraterritorial effect. Recently, the doctrine has been succinctly explained as follows: “But extraterritorial effect means seeking to regulate the conduct or affect the liabilities of people over whom the United Kingdom has no jurisdiction” (Office of Fair Trading v. Lloyds TSB Bank plc [2007] UKHL 48, [2008] 1 AC 316, para. 4, per Lord Hoffmann). In another recent case, Lord Rodger of Earlsferry said: “It would usually be both objectionable in terms of international comity and futile in practice for Parliament to assert its authority over the subjects of another sovereign who are not within the United Kingdom. So, in the absence of any indication to the contrary, a… Read more »