Attacks on the Securities and Exchange Commission (SEC) by the left and the right, hostility to the agency by the courts, an overload of rule-making obligations imposed by recent federal statutes, and partisan politics in Congress and on the commission are taking a toll on the ability of the SEC to formulate coherent policy. Such regulatory ossification is exhibited in the recent SEC staff study on the scope of Section 10(b) actions in cross-border private cases.1 Commissioner Luis Aguilar issued an impassioned dissent2 from the staff study, arguing that the study “fails to satisfactorily answer the Congressional request, contains no specific recommendations, and does not portray a complete picture of the immense and irreparable investor harm that has resulted, and will continue to result,” from the failure to extend Section 10(b) to cross-border private cases.3

This controversy emanates from the decision of the U.S. Supreme Court in Morrison v. National Australia Bank,4 which cavalierly discarded more than 40 years of precedent in the lower courts applying the conduct and effects test to cross-border disputes arising under Section 10(b) of the Securities Exchange Act of 1934.5 The court substituted a new transactional test limiting Section 10(b) to frauds “in connection with the purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.”6 Almost simultaneously, the Congress, in the Dodd-Frank Act of 2010, restored the ability of the SEC and the Department of Justice to bring actions under Section 10(b) in cases of transnational fraud,7 and directed the SEC to conduct a study to determine whether private rights of action should be similarly restored to private plaintiffs.8

In Schoenbaum v. Firstbrook,9 the U.S. Court of Appeals for the Second Circuit determined that the presumption against extraterritorial application of legislation does not show congressional intent to preclude application of the Exchange Act to transactions effected outside the United States in stocks traded in the United States, “when extraterritorial application of the Act is necessary to protect American investors.”10

Therefore, the court held that federal courts have subject matter jurisdiction over violations of Section 10(b) although the transactions violating the Exchange Act take place outside the United States, if the transactions involve stocks registered on a national securities exchange, and are detrimental to American investors.

Schoenbaum was extended in a series of Second Circuit decisions establishing the conduct and effects test, which applied Section 10(b) in cross-border cases where either the wrongful conduct had a substantial effect in the United States or upon U.S. citizens or the wrongful conduct occurred in the United States.11 These cases influenced the development and application of the law regarding the extraterritorial application of Section 10(b) in other circuits as well as the formulations of the American Law Institute.12

Morrison was a suit by plaintiffs seeking to represent allegedly defrauded purchasers of the common stock of National Australia Bank (NAB). The ordinary shares of NAB stock were listed and traded on the Australian and other foreign stock exchanges; American Depositary Receipts (ADRs) were listed and traded on the New York Stock Exchange. In 2001, NAB announced a significant write-down of HomeSide Lending, Inc., a mortgage servicing company located in Florida, probably due to improper accounting practices at this subsidiary, and the stock of NAB slumped. The petitioning plaintiffs in Morrison were foreign purchasers of NAB stock, who purchased their shares abroad. The District Court and the Second Circuit dismissed the case, applying the conduct and effects test.

There was no need for the Supreme Court to take this case, except to further its campaign to limit Section 10(b) class actions to the extent possible. Justice Antonin Scalia’s majority opinion is blatantly political. He claims that the “Second Circuit never put forward a textual or even extratextual basis for [the conduct and effects] tests.”13 He takes a snarky sideswipe at both Judge Henry Friendly, who is generally credited with developing this test, and Justice John Paul Stevens, who wrote a concurring opinion defending the conduct and effects test.14 Scalia claimed that at least one court of appeals criticized the conduct and effects test and the interpretative assumption underlying it, citing a 1987 opinion by Judge Robert Bork in the U.S. Court of Appeals for the D.C. Circuit.15

In fact, the presumption against extraterritorial application of the Exchange Act, relied upon by the court in Morrison, has been inconsistently applied by the Supreme Court, which has adopted an effects test in antitrust litigation.16 While the intent of Congress to apply the Exchange Act extraterritorially could certainly be clearer, the statute applies to “interstate commerce” which is defined to include “trade, commerce, transportation, or communication…between any foreign country and any State.”17 Additionally, Section 30 specifically addresses foreign securities businesses and exempts them from the statute.18 In Schoenbaum and other cases, the Second Circuit relied upon these provisions, as well as the congressional policy of protecting U.S. investors.

Policy Reasons

There are two primary policy reasons cited by the court in Morrison for reformulating the test for accepting jurisdiction in cross-border fraud cases. The first is that the conduct and effects test was not easy to administer and so it produced unpredictable and inconsistent applications.19 This criticism is answered by Stevens in pointing out that the entire area of law under Section 10(b) is “replete with judge made rules, which give concrete meaning to Congress’ general commands.”20 Accordingly, the court should have given weight to the Second Circuit’s judge-made doctrine instead of “denigrating it” in order to render Section 10(b) “toothless.”21

Further, the court’s new test will lead to decisions that are at least as unpredictable and inconsistent as the conduct and effects test. This has already happened.22 In today’s global capital marketplace, where it is difficult to determine where cross-border securities transactions occur,23 the court’s doctrinal emphasis on the locus of a trade is rooted in a view of securities transactions prior to the Internet age.

Another policy reason cited by the court in Morrison is international comity. While many amici in Morrison and commenters mentioned in the SEC’s staff study invoked comity as a reason for U.S. courts to decline jurisdiction in cross-border cases, the lower federal courts have proven quite capable of applying comity or forum non conveniens in dismissing cases involving fraud cases instituted by foreign plaintiffs who purchase foreign securities abroad.24

It is not surprising that an activist, conservative Supreme Court narrowed the scope of private cross-border fraud cases in Morrison, but it is surprising that there was so little push-back from the SEC, even though Congress invited the commission to argue for legislation to roll back Morrison. In Dodd-Frank the SEC was directed to solicit public comments and then conduct a study on whether private actions under Section 10(b) should be extended to reach:

(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.25

Dodd-Frank further provided that the SEC study should consider and analyze the scope of any private right of action, its implications on international comity, its economic costs and benefits and whether a narrower extraterritorial standard than that enacted for government actions should be adopted.26

The Staff Study

The staff study details the holdings of Morrison in the lower courts and Supreme Court, and the arguments made in the various briefs filed, summarizes the contradictory comments filed in response to the SEC’s request for comments,27 concludes that “evidence in the academic literature and the results of our event study on the Morrison decision are inconclusive as to the net benefits or costs of a cross-border extension of private rights of action,”28 and fails to make any recommendations to Congress for a statutory amendment to the Exchange Act.

Rather, the staff study lays out various options that Congress might consider in deciding whether to amend the Exchange Act, including taking no action.29

One argument made by commenters supporting the transactional test of Morrison, and opposing an extension of Section 10(b) to private plaintiffs, was that this would create significant conflicts with the laws of other nations. These commenters included foreign governments, issuers, law firms and accounting firms. Others argued that in today’s markets it is not possible to be certain where a transaction takes place, and moreover, the transactional test impairs the ability of investment funds to achieve a diversified investment portfolio, and forces them to buy ADRs rather than ordinary shares of foreign companies.30

Many commenters, including both U.S. and foreign institutional investors, law firms, investor organizations and academics, advocated restoring the conduct and effects test.31 Opponents reiterated the arguments in the Morrison briefs that the conduct and effects tests impaired U.S. relations with other nations, increased litigation costs, and diverted U.S. judicial resources.32 Some commenters suggested alternative approaches to the conduct and effects test including adoption of such a test limited to U.S. resident investors and a fraud-in-the-inducement test.33

The staff’s first alternative is to tweak the conduct and effects test so that a private plaintiff seeking to bring a Section 10(b) action “must demonstrate that the plaintiff’s injury resulted directly from conduct within the United States.”34 Alternatively, the conduct and effects test could be made available only to U.S. investors.35

The staff study also set forth several options to supplement and clarify the transactional test, rather than reinstating the conduct and effects test. These were: to permit investors to sue in private actions for the purchase and sale of any security that is of the same class of an SEC registered security; to authorize actions against securities intermediaries that engage in fraud against U.S. investors overseas; to permit suits by investors who were fraudulently induced while in the United States to engage in a securities transaction; or to clarify that an off-exchange transaction takes place in the United States if either party made an offer or accepted an offer while in the United States.36

There are numerous ways in which the Morrison transactional test, in the name of international comity, interferes with legitimate U.S. investor protection concerns. These include the perpetration of securities fraud on U.S. citizens living abroad, including members of the armed services, and securities frauds perpetrated on investors by nominally foreign corporations that are in fact U.S. companies.37 Very importantly, this test does not properly focus on the way in which ordinary shares of companies with U.S.-listed ADRs trade in tandem with ADRs of such companies so that fraudulent activity by the issuers of such securities injure U.S. investors and U.S. domestic markets.

Moreover, the ordinary shares into which the ADRs can be exchanged are also listed on a U.S. exchange. It can therefore be argued that under the Morrison test, any plaintiff who purchased ADRs should not have been dismissed, and perhaps the entire case should have been allowed to go forward.38 Unfortunately, the staff study does not shed much light on these and other problems with the Morrison decision or come to any conclusions or clear recommendations as to how these problems can be rectified by Congress.

Roberta S. Karmel is Centennial Professor of Law and co-director of the Dennis J. Block Center for the Study of International Business Law at Brooklyn Law School. She is a former commissioner of the Securities and Exchange Commission. Michael Russo, a Brooklyn Law School student, assisted in the preparation of this column.


1. Staff of the U.S. Securities and Exchange Commission, Study on the Cross-Border Scope of the Private Right of Action Under Section 10(b) of the Securities Exchange Act of 1934 As Required by Section 929Y of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“staff study”) (April 11, 2012), available at

2. Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, Statement by Commissioner: Defrauded Investors Deserve Their Day in Court (April 11, 2012), available at

3. Id.

4. 130 S. Ct. 2869 (2010).

5. 15 U.S.C. §78j(b) (2006).

6. 130 S. Ct. at 2888.

7. Section 929P(b)(2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), Pub. L. No. 111-203, §929P(b)(2), 124 Stat. 1376 (2010).

8. Id. at §929Y.

9. 405 F.2d 200 (2d Cir. 1968), cert. denied, 395 U.S. 906 (1969).

10. Id. at 206.

11. 130 S. Ct. at 2879. See, e.g., Leasco Data Processing Equip. v. Maxwell, 468 F.2d 1326 (2d Cir. 1972); Bersch v. Drexel Firestone, 519 F.2d 974 (2d Cir. 1975); IIT v. Vencap, 519 F.2d. 1001, 1017-18 (2d Cir. 1975).

12. Restatement (Third) of Foreign Relations Law of the United States §416 (1987); Fed. Sec. Code §1905(a) (1980). These developments were analyzed by the author in Roberta S. Karmel, The Second Circuit’s Role in Expanding the SEC’s Jurisdiction Abroad, 65 St. John’s L. Rev. 743 (1991).

13. 130 S. Ct. at 2879.

14. Id. at 2880 n. 4.

15. Id. at 2880 (citing Zoelsch v. Arthur Andersen, 824 F.2d 27, 32 (1987) (D.C. Cir. 1987)).

16. See F. Hoffman-LaRoche v. Empagran, 542 U.S. 155, 158-59 (2004).

17. 15 U.S.C. §78c(17) (2006).

18. 15 U.S.C. §78dd (2006).

19. 130 S. Ct. at 2880.

20. Id. at 2889 (Stevens, J., concurring in the judgment).

21. Id. at 2891, 2895.

22. See staff study, at 28-39 (analyzing lower federal court cases decided after Morrison).

23. Comments by Forty-two Law Professors, Feb. 18, 2011, File No. 4-617, Rel. No. 34-63174, available at The author was one of the signatories to this letter. See also staff study at 43.

24. In Re Vivendi Universal Sec. Litig., 765 F.Supp.2d 512 (S.D.N.Y. 2011); Robinson v. TCI/US West Communications, 117 F.3d 900 (5th Cir. 1997). Nevertheless, the courts have not always been sufficiently sensitive to claims of comity. See, e.g., Consolidated Gold Fields v. Minorco, 871 F.2d 252, modified, 890 F.2d 569 (2d Cir. 1989).

25. Dodd-Frank, §929Y(a). See also staff study at 7.

26. Id. at §929Y(b).

27. Study on Extraterritorial Private Rights of Action, Exchange Act Release No. 63174 (Oct. 25, 2010). See also staff study, at 39-58.

28. Staff study, at B13.

29. It was the inclusion of this option of doing nothing that so raised the ire of Commissioner Aguilar to prompt his dissent.

30. See staff study, at 42-47.

31. Id. at 49-52.

32. Id. at 53-55.

33. Id. at 55-58.

34. Id. at 61.

35. Id. at 63.

36. Id. at 64-69.

37. As pointed out by Commissioner Aguilar, the case against Tyco International Ltd., In re Tyco Int’l Ltd. Multidistrict Litig., 535 F.Supp.2d 249 (D.N.H. 2007), in which U.S. investors received, in part, $3.2 billion in monetary relief, may well have been dismissed under Morrison. See Statement by Commissioner, at 5.

38. Robert Morrison, the named plaintiff was actually an American investor in NAB’s ADRs, but the district court dismissed the complaint against him for his failure to allege damages. 130 S. Ct. at 2876 n. 1.