Companies with significant operations in the United States but offering securities in other countries should beware. After almost seven years of uncertainty, it finally has been determined by one court that the Securities and Exchange Commission’s (SEC) power to bring enforcement actions extends beyond the border to companies that market securities abroad to foreign investors, even if they do not have any securities listed or sold in this country, if they have substantial operations here.
Back in the summer of 2010, the Supreme Court and Congress got into a tussle over the extraterritorial application of federal securities laws. Prior to that point, courts permitted private plaintiffs and the government to bring extraterritorial claims under the federal securities laws based on whether significant wrongful conduct related to the transaction at issue occurred in the U.S. or whether wrongful conduct had had a substantial effect in the U.S. However, this “conduct or effects” test was rejected by the Supreme Court in its Morrison v. National Australia Bank, 561 U.S. 247 (2010) opinion issued on June 24, 2010. Instead, the Supreme Court instituted a new “transactional” test. This test hinges on the purchase or sale of the security at issue taking place in the U.S. or the security being traded on an American stock exchange. Consequently, the risk to companies of being subjected to enforcement actions by the SEC relating to offering securities abroad was reduced considerably.
Less than one month after Morrison, the Dodd-Frank Act was signed into law. Section 929(b) includes language that seemed to restore the “conduct and effects” test for government securities actions. Thus, the question arose of whether the more limited transactional test or the broader conduct and effects test was applicable to actions brought by the SEC. Until last month, courts had avoided deciding the issue.
The case SEC v. Traffic Monsoon, LLC, No. 2:16-cv-00832-JNP, 2017 WL 1166333 (D. Utah Mar. 28, 2017) resolved the issue in favor of the SEC being able to extend its reach by employing the conduct and effects test. Traffic Monsoon, targeted by the SEC, was an internet advertising company that sold advertising packages to members, 90% of which resided outside of the U.S. The SEC alleged the company was engaged in an illegal Ponzi scheme in violation of certain federal securities laws. The Court held that the Dodd-Frank Act superseded Morrison, thus making the conduct and effects test apply to the SEC’s extraterritorial securities actions. More specifically, the SEC’s allegations against Traffic Monsoon’s activities passed the conduct and effects tests because the company operated in the U.S. while allegedly defrauding investors abroad. Nonetheless, out of an abundance of caution, the court also found that it passed the transaction test given that the purchases were made over the internet and liability had been incurred in the U.S. to deliver the products to the buyers.