Limiting Extraterritoriality Beyond Securities Laws
By Alan Brudner, Stephen Trigg, and Mor Wetzler — October 27, 2011
In Morrison v. National Australia Bank, Ltd., 561 U.S. ___, 130 S. Ct. 2869 (June 24, 2010) the U.S. Supreme Court affirmed the dismissal of a securities class action in which a foreign issuer was sued by foreign plaintiffs who bought their securities on a foreign exchange. Morrison’s effect on securities actions has been immediate and significant—the case has etched the term “F-Cubed” into the practitioner’s lexicon. However, Morrison also has had a significant impact on the extraterritorial application of non-securities statutes.
Morrison and the Presumption Against Extraterritorial Application
In Morrison, foreign investors purchased shares of a foreign company on a foreign exchange. They later brought a securities fraud claim in a U.S. court under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 thereunder. The district court dismissed the claims as lacking subject-matter jurisdiction, and the Second Circuit affirmed on appeal. Applying its test for determining when the Exchange Act should apply to transnational securities fraud, the Second Circuit examined whether sufficient wrongful conduct had occurred in the United States to trigger section 10(b). The Second Circuit affirmed the dismissal, concluding that the conduct central to the alleged fraud had occurred entirely overseas and that any U.S. connection was too attenuated from the plaintiffs’ alleged injury.
On appeal, the U.S. Supreme Court affirmed. The Supreme Court first determined that the extraterritorial application of section 10(b) is not a question of subject matter jurisdiction: “to ask what conduct § 10(b) reaches is to ask what conduct § 10(b) prohibits, which is a merits question.” Next, the Court addressed two tests generally employed by lower courts to determine the extraterritorial application of section 10(b) and rejected both. These tests were the “conduct” test (whether the wrongful conduct occurred in the United States) and the “effects” test (whether the wrongful conduct had a substantial effect in the United States or on U.S. citizens). The Court explained that these two tests are textually unsupported and that they ignore the “longstanding principle of American law that legislation of Congress, unless a contrary intent appears, is meant to apply only within the territorial jurisdiction of the United States.” The Court clarified that this presumption against extraterritorial application should apply “in all cases, preserving a stable background against which Congress can legislate with predictable effects.” The Court then applied the presumption and found no “affirmative indication” in the statute that Congress intended Section 10(b) to apply extraterritorially.
Morrison Beyond the Securities Laws
Morrison’s presumption has been applied, with varying results, to limit the extraterritorial application of other U.S. laws, including the Racketeer Influenced and Corrupt Organizations Act (RICO).
A RICO claim (see 18 USC §§ 1961–68) requires proof of four elements: there must be an enterprise affecting interstate commerce; the defendants must have been employed by or associated with the enterprise; the defendants must have participated, directly or indirectly, in the conduct or affairs of the enterprise; and the defendants must have participated through a pattern of racketeering activity that must include at least two predicate acts of racketeering. Examples of predicate acts include state felonies such as murder, kidnapping, or extortion, or federal crimes such as mail fraud or wire fraud. The Supreme Court has interpreted the “pattern” requirement to include requirements of “relatedness” (same or similar purposes, results, participants, victims, or methods) and “continuity” (the series extends over time; at least two acts must be within 10 years of one another). See, generally, H.J Inc. v. Northwestern Bell Tel. Co., 492 U.S. 229 (1989). In many cases, the racketeering enterprise crosses international borders. Specific predicate acts potentially occur in the United States while the effects of those acts are felt only abroad. Following Morrison, courts have struggled with the extraterritorial application of RICO.
The extraterritorial application of RICO pre-Morrison largely mirrored the securities case law. The Second Circuit decision in Alfadda v. Fenn, 935 F.2d 475 (2d Cir. 1991) is illustrative of this. Investors in the defendant, Saudi European Investment Corporation N.V. (SEIC), alleged they were defrauded when their stake in SEIC was diluted by sales in breach of an offering prospectus and that the defendants diverted the proceeds from the sales for their own benefit. The plaintiffs brought claims for violations of RICO, the Securities Exchange Act, rule 10b-5, and various state-law claims. The district court held that it lacked jurisdiction after finding that the alleged fraud was perpetrated outside the United States. The Second Circuit reversed this decision and remanded for further proceedings based on the plaintiffs’ allegations that fraudulent conduct occurred in the United States. Various meetings and sales that allegedly diluted the plaintiffs’ holdings occurred within the United States, even though the allegedly fraudulent prospectuses were delivered to them outside the country’s borders.
The Second Circuit explained that, “[l]ike the Securities Exchange Act, the RICO statute is silent as to its extraterritorial application. Thus, we must ascertain whether Congress would have intended that federal courts should be concerned with specific international controversies.” Alfadda, 935 F.2d at 479. The court recognized the lack of Second Circuit precedent regarding the extraterritorial application of RICO but rejected the arguments circumscribing RICO’s extraterritorial application to foreign enterprises. The court then applied the “conduct” test for determining the application of securities fraud laws to determine whether RICO applied to the facts before it. The court concluded that the sales that diluted the plaintiffs’ holdings were predicate acts that occurred primarily in the United States; hence, they were a sufficient basis of jurisdiction for the RICO claims.
In North-South Finance Corp. v. Al-Turki, 100 F.3d 1046 (2d Cir. 1996), the court discussed the application of the “effects” test—used in the securities and antitrust contexts—to determine the extraterritorial application of RICO. The case concerned a dispute among groups of foreign companies and foreign nationals, arising out of the sale and reorganization of a French bank. The all-foreign plaintiffs alleged under RICO that two French investment-banking groups who acquired the bank artificially depressed the sale price of the bank by corrupting its general manager and manipulated post-sale transactions so that contingent payments of the purchase price would be fraudulently reduced or eliminated. Connections to the United States included a New York office of the bank and post-sale transactions that occurred in the United States.
The district court ruled that the extraterritorial reach of RICO in a given case was determined by whether the “conduct” of the defendants in the United States “was material to the completion of a racketeering act.” The Second Circuit did not decide whether the test that had been applied by the district court was the only available test but affirmed the dismissal of the RICO claims because the defendants’ alleged conduct in the United States was insufficient to support subject-matter jurisdiction under RICO.
The court reiterated that the RICO statute is silent as to extraterritorial application and that a corporate defendant that is a foreign entity is not, for that reason alone, shielded from the reach of RICO. Less clear was what character and amount of activity in the United States would justify RICO jurisdiction over a foreign entity. The court reviewed the application of securities and antitrust laws outside the United States and noted that the tests for asserting jurisdiction extraterritorially varied depending on the substantive law to be applied abroad. The court stated, “It may be that the effects-oriented approach borrowed from antitrust cases is an equally or even more appropriate test [than the conduct test], especially since the ‘the civil action provision of RICO was patterned after the Clayton Act’” and RICO provides for treble damages, which heightens concerns regarding international comity and foreign enforcement.
Because Morrison rejected the “conducts” and “effects” tests, it is not surprising that post-Morrison cases considering RICO’s extraterritorial application reflect a drastically different type of analysis. In the first case to apply Morrison to RICO, the plaintiffs sought “‘damages arising out of a wide-ranging money laundering scheme that utilized New York-based U.S. banks to hold, move and conceal the fruits of fraud, extortion, and private abuse of public authority’ by Venezuelan government officials and their confederates.” Cedeno v. Intech Group, Co., 733 F. Supp. 2d 471 (S.D.N.Y. 2010). The alleged scheme’s contacts with the United States were limited to the movement of funds through U.S. banks. Some of the defendants moved to dismiss on the grounds that the complaint exceeded the territorial limits of RICO’s reach.
Initially, the court noted Morrison’s repudiation of the prior “effects” and “conduct” tests employed to determine the extraterritoriality of statutes that were silent on the issue, noting the need to examine congressional intent in enacting the statute. Citing North South Finance Corporation for the proposition that RICO is silent as to any extraterritorial application, the court determined that, under Morrison, the RICO statute is presumed not to apply to claims that are essentially extraterritorial.
The plaintiffs argued that their claims survived Morrison because they alleged predicate acts of money laundering involving transfers to and from the Southern District by U.S. banks. In response, the court quoted language from Morrison that the presumption against extraterritoriality would be a craven watchdog if it retreated to its kennel whenever some domestic activity was involved in the case. The court reasoned that RICO is not so concerned with the predicate acts but is focused instead on the enterprise and how it is affected by the pattern of racketeering—and nowhere does the statute evidence any concern with foreign enterprises, let alone a concern sufficient to overcome the presumption against extraterritoriality. According to the court, where the alleged enterprise and the impact of the predicate activity on it are entirely foreign, RICO does not apply.
The next case to address RICO and extraterritoriality was Norex Petroleum, Ltd. v. Access Industries, Inc., 631 F.3d 29 (2d Cir. 2010). The plaintiff, Norex, alleged that the defendants conspired to take control of a Russian oil company and reduce Norex from the controlling majority shareholder to a minority one. This was allegedly done through a widespread racketeering and money-laundering scheme with the goal of seizing control of most of the Russian oil industry. The plaintiff alleged that numerous acts committed within the United States in furtherance of the scheme constituted racketeering within the meaning of RICO. These acts allegedly included mail and wire fraud, money laundering, Hobbs Act violations, Travel Act violations, and bribery.
The court noted that Morrison rejected the “conduct” and “effects” tests and wholeheartedly embraced the presumption against extraterritoriality. The court next considered Second Circuit precedent, namely the Al-Turki case discussed above, finding that RICO is silent as to any extraterritorial application. The court then turned to Norex’s arguments for applying RICO extraterritorially. First, Norex argued that RICO’s definition of interstate commerce includes foreign commerce. The court explained that Morrison foreclosed this argument by noting that even statutes containing broad language in their definitions of commerce do not apply abroad. Next, Norex argued that because some of RICO’s predicate acts possess an extraterritorial reach, RICO itself possesses an extraterritorial reach. Morrison rejected the same argument regarding section 30(b) of the Exchange Act by noting that the presumption against extraterritoriality operates to limit that provision to its terms. Finally, Norex argued that its allegations regarding domestic conduct were sufficient to support the domestic application of RICO. Finding these slim contacts insufficient, the court rejected this. In response to concerns regarding the government’s application of RICO, the court amended the decision to add a statement that the court did not express any opinion on the extraterritorial application of RICO when enforced by the government.
The next case to address the extraterritorial application of RICO was European Cmty. v. RJR Nabisco, Inc., 2011 U.S. Dist. Lexis 23538 (E.D.N.Y. Mar. 8, 2011). The European Community and 26 European countries brought a RICO action against various American cigarette manufacturers in relation to their cigarette sales practices. Specifically, the plaintiffs alleged that the defendants participated in a global money-laundering scheme involving Colombian and Russian criminal organizations and the exchange of illicit drugs, Euros, and cigarettes.
Citing Norex, the court noted that RICO’s silence as to any extraterritorial application prohibited extraterritorial application. The court next considered whether the claims at issue warranted extraterritorial application of RICO. The court reviewed the focus of the statute, the activities it seeks to regulate, and the parties to those activities whom the statute seeks to protect. After analyzing the statute, the court determined that the focus of the statute was on enterprises; it seeks to regulate enterprises by protecting them from being victimized by or conducted through racketeering activity. Because RICO applies only to domestic enterprises, the court examined enterprise location for RICO purposes. The court compared the analysis to determining the geographic location of a corporation and adopted the nerve center test for determining principal place of business. To determine an enterprise’s location, the court focused on the decisions effectuating the relationships and common interest of its members, as well as how those decisions were made.
Applying the nerve center test to the complaint, the court noted that none of the allegations even remotely suggested that the cigarette companies had any hand in the planning, decisions, or overall corporate policy of many of the steps involved in the scheme. Instead, the cigarette companies were mere sellers of fungible goods. Moreover, the alleged overall corporate policy of the enterprise issued from various criminal organizations located outside the United States. On this basis, the court dismissed the RICO claims against the cigarette companies.
More recently, the U.S. District Court for the District of Columbia considered Morrison’s effect on RICO in United States v. Phillip Morris USA, Inc., 2011 U.S. Dist. Lexis 32053 (D.D.C. Mar. 28, 2011). The case involved an alleged scheme to defraud smokers and potential smokers for purposes of financial gain by making false and fraudulent statements, representations, and promises in violation of RICO sections 1962(c) and (d). One of the defendants was the British American Tobacco (Investments), Ltd. (BATCo). On August 17, 2006, the court issued an opinion ruling that all the defendants, including BATCo, were liable. On May 22, 2009, the D.C. Court of Appeals affirmed the judgment of liability and other provisions in a remedial order. On December 28, 2010, the United States moved to compel BATCo’s compliance with the 2006 order, which BATCo opposed based on the intervening Morrison decision.
BATCo is organized under the laws of England and Wales, and its principal place of business is in England. Its officials and scientists attended some meetings with other defendants in the United States. BATCo had been found liable because its activities and statements furthered the enterprise’s overall scheme, which had a large impact on the United States. BATCo argued that because Morrison changed the law concerning the use of the “effects” test to determine extraterritoriality, the legal basis for the finding of liability against it was invalid. The government argued that the Morrison decision did not turn principally on the presumption against extraterritoriality and that the case was meant to apply only to Section 10(b) of the Securities Exchange Act. Moreover, the government argued that some of the predicate acts giving rise to RICO liability are extraterritorial in nature, so Congress must have meant for RICO to have extraterritorial scope.
The court analyzed Morrison and determined that its holding—that, when a statute does not have a clear indication of extraterritorial reach, it does not have any—applies to all statutes. The court also found there was no evidence that Congress intended to criminalize foreign racketeering activities under RICO. Finally, BATCo’s limited domestic conduct was not enough to apply RICO to essentially foreign activity, and BATCo’s domestic conduct had not been the basis for its RICO liability. Thus, the court found that Morrison invalidated the basis for liability against BATCo and refused to compel BATCo to comply with the 2006 order.
In at least some situations, Morrison has been held not to affect the analysis regarding extraterritoriality. In Love v. Associated Newspapers, 611 F.3d 601 (9th Cir. 2010), for example, the Ninth Circuit addressed the effect of Morrison on its Lanham Act jurisprudence. The case involved the Beach Boys and the distribution of CDs in Britain. The court employed a three-part test borrowed from the antitrust context to analyze the Lanham Act’s coverage of foreign activities. In a footnote, the court addressed Morrison.
The court differentiated the Lanham Act from the securities laws based on statutory language. The court said that according to Ninth Circuit precedent, “commerce” for Lanham Act purposes is sweepingly defined as all commerce that may lawfully be regulated by Congress. According to the court, the breadth of this language contrasted readily with the language of the securities laws at issue in Morrison. The Lanham Act language did not refer merely to foreign commerce but expressly covered all commerce Congress could regulate. This language represented a clear indication that the statute applied extraterritorially. Therefore, the court saw no reason to revisit its case law regarding the extraterritorial application of the Lanham Act.
State Blue-Sky Laws and Dormant Commerce Clause Analysis
Morrison’s transactional test has also been adopted by at least one court in determining the permissible reach of state blue-sky laws. For example, the court in In re National Century Financial Enterprises, Inc., addressed whether Credit Suisse Securities, LLC, was liable under Ohio’s blue-sky laws for its role in the sale of asset-backed securities issued by National Century Financial Enterprises, Inc. 2010 U.S. Dist. Lexis 131724 (S.D. Oh. Dec. 13, 2010). Credit Suisse argued that the transactions at issue occurred wholly outside of Ohio and that to apply the Ohio statute to it would violate the dormant commerce clause.
The Ohio Securities Act said little about its territorial reach. Prior precedent held that the Ohio statute could be applied to securities transactions between a non-Ohio seller and a non-Ohio buyer, so long as the issuer was from Ohio and the seller had significant contacts with the issuer. The court determined that the Ohio statute applied to the situation before it but then addressed whether that ran afoul of the Dormant Commerce Clause prohibiting states from passing legislation that discriminates against interstate commerce. The court discussed multiple tests that had been used to determine whether a statute was being applied extraterritorially.
The court concluded that the Ohio Securities Act focused on the securities transactions, not on the fraud perpetrated upon the buyers. The plaintiffs’ attempt to impose liability on Credit Suisse merely for participating or aiding in making the sale, not for committing the fraud, would impose a burden on interstate commerce by rescinding sales of securities that take place entirely in other states under whose laws the transactions would not be rescinded without a further element of intent or knowledge. The fact that a particular transaction may affect or impact a state does not license that state to regulate commerce occurring outside of its jurisdiction. Accordingly, the court adopted the Morrison transactional test and held that the Ohio Securities Act did not apply extraterritorially.
Morrison has had an immediate and significant impact on areas of law outside of the securities context, particularly in RICO cases. Morrison has also superseded the tests used to determine extraterritorial applicability in other areas, such as the Lanham Act, and in reviewing the permissible reach of state laws under Dormant Commerce Clause analysis. The reasoning and language of Morrison thus puts new moves on the litigation chessboard when a case or controversy has international components, particularly with respect to international parties whose links to the United States are attenuated.
Keywords: litigation, international litigation, Securities Exchange Act, Racketeer Influenced and Corrupt Organizations Act, Morrison v. National Australia Bank, Ltd.
Alan Brudner is a partner and Stephen Trigg and Mor Wetzler are associates with Paul Hastings, LLP, New York, New York.